Seeking advice on how to make money work

[wildcat]

I think we all know the traditional order of putting our money to use. In other words, if a person has credit card debt @ 20% then he/she should pay that off first. New scenario for me...

Suppose (as most of us expect) stock market returns remain moderate to low. Suppose a person has quite a bit of student loans and/or other low interest debt. If neither one is a clear cut best place to put money to work what should I do?

Any suggestions with before and after tax money? Should I accumulate and then pay off student loan debt more aggressively when I get closer to a desirable retirement age?

I think Roth IRA is a sure thing but beyond that I am not sure what to do....keep in mind I am pretty young. Thanks as always.

 

[JPatrick]

I'm not sure how young you are or when you will be close to retirement, but waiting til you are close to retiring to worry about student loans seems a little out of wack.
I think you ought to max out your ROTHs and any match you may have in a 401K and then pound away at the debt.
If you have any money left at that point grab some good index funds and toss them in the drawer.
One of the keythings you said is "young."  While debt of any kind is not great, it is also critical that you take advantage of the magic of compounding over your lifetime. It really is magic.  When I look back at my records and see funds I bought 25 years ago it pretty clearly shows the value of compounding and of course, reinvesting earnings automatically.  Incredible gains, and all I did to earn these gains was sit on my butt and grow older. 8)

 

[maddythebeagle]

It all depends on how you feel about debt. You are either disciplined (and make the decisions based on the math) or just want all of the debt gone (ala gurus like brother Dave Ramsey and the like that cant control their consumer spending), or a combo. of both. I think all work but for different people.

 

[unclemick]

Let me put my age 62 grumpy curmudgeon in training to the test:

I never worried about credit card/car payment debt - used and abused it in my accumulation phase.

The single most important thing (benifit of hindsight again) was to max any tax deferred vehicle availible - IRREGARDLESS OF MARKET CONDITIONS.

IT WASN"T MY MONEY - the 'Godfather of retirement' got his cut off the top via auto deduction. Time in the market - not market timing - an offer I couldn't refuse.

Paycheck to paycheck on 'my' cut - varied between wild and free - slam on the break frugal - and legend in my own mind investments.

After 29 yrs at the tender 'old age' of 49 1/2 - the boring old Godfather cut turned out to be 80-90% of ER stash - depending on how you count the rental duplex along the way.

Lots of ways to ER - but boring as paint drying - DCA was ours.

 

[Mr._johngalt]

Let me put my age 62 grumpy curmudgeon in training to the test:

I never worried about credit card/car payment debt - used and abused it in my accumulation phase.

The single most important thing (benifit of hindsight again) was to max any tax deferred vehicle availible - IRREGARDLESS OF MARKET CONDITIONS.

IT WASN"T MY MONEY - the 'Godfather of retirement' got his cut off the top via auto deduction. Time in the market - not market timing - an offer I couldn't refuse.

Paycheck to paycheck on 'my' cut - varied between wild and free - slam on the break frugal - and legend in my own mind investments.

After 29 yrs at the tender 'old age' of 49 1/2 - the boring old Godfather cut turned out to be 80-90% of ER stash - depending on how you count the rental duplex along the way.

Lots of ways to ER - but boring as paint drying - DCA was ours.

I also "used and abused" the CCs for years, then...............abruptly
I jumped off the plane (biplane in my case) with no parachute.

Like you said "Lots of ways"..........

JG

 

[Mr._johngalt]

It all depends on how you feel about debt. You are either disciplined (and make the decisions based on the math) or just want all of the debt gone (ala gurus like brother Dave Ramsey and the like that cant control their consumer spending), or a combo. of both. I think all work but for different people.

While I understand "wanting all the debt gone" (I am pretty much debt free
except for all of those CC promo rates), if I was still in my accumulation
phase I would be neck deep in debt due to my preference for real estate
investment. Leverage has made just as many fortunes as compounding.


JG

 

[wildcat]

I'm not sure how young you are or when you will be close to retirement, but waiting til you are close to retiring to worry about student loans seems a little out of wack.

Let me clarify, i.e. when I get about 10 years away which is close to me when compared to my target of 23 years or slightly less.

The single most important thing (benifit of hindsight again) was to max any tax deferred vehicle availible - IRREGARDLESS OF MARKET CONDITIONS

Probably right on with that remark

 

[maddythebeagle]

I wouldnt consider those CC promo rates as debt for you since you havent "spent it" It's all there right collecting over 3% interest>

 

[justin]

Wildcat,

I'm in a very similar position as you. My wife and I owe a lot on our student loans. Mine should be paid back in 26-32 years. But at a fixed rate of about 1% APR, I would be crazy to prepay anything on my student loans. No math needed for me. Student loans also have the deferral/forebearance option, above the line tax deductible interest, and in the event of death, the principal balance still owed is waived (free life insurance!).

Keep in mind that most of the proceeds from my student loans were invested (in real estate, Roth IRA stock funds, etc). I never saw the need to spend all the money that was given to me, since I was able to find great summer jobs paying very good money sufficient to support me during school when I wasn't working.

Our student loan debt is a few times our net worth, but the monthly payments are very small, and we have most of the proceeds of our loans invested. The loan balances keep dropping, and our net worth goes up. I will certainly have the student loans well into my retirement (if things go as planned...).

 

[maddythebeagle]

Hey justin: if it works for you. I have seen some of your other posts, and view you as a pretty rational guy. I personally wouldnt want the debt into my retirement for something that was paid for so many years in the past, but that's just me, but I guess it really didnt fund your education, it is borrowing money to invest, really.

 

[wildcat]

above the line tax deductible interest

Thanks for the post. Just kind of feels like a burden. I think I read that Bush is rolling back the tax deductible interest on S/L.

 

[justin]

Hey justin: if it works for you. I have seen some of your other posts, and view you as a pretty rational guy. I personally wouldnt want the debt into my retirement for something that was paid for so many years in the past, but that's just me, but I guess it really didnt fund your education, it is borrowing money to invest, really.

My current student loan payment is around $250. In 10, 20 or 30 years, I'll still be paying that $250. Due to inflation that $250 will be $186, $138, and $103, respectively, in 2005 dollars. True, I'll have slightly higher expenses in retirement (for the first decade or two). I'll also have received the benefits of 10, 20 or 30 years of compounded growth from the nearly interest free money. I can always pay it off before retirement, since by then I will have paid down a significant amount of the principal, and the balance will be relatively small due to inflation. Mortgage works the same way, but it is a little higher than $250 per month. The rate on the mortgage is higher, and adjustable, so I am paying it down first.

I look at debt as a tool. If someone will lend me money at below market interest rates, I'll take it in a heartbeat!

 

[maddythebeagle]

rolling back the tax deductible interest on S/L.

- I think it has gone in cycles. My sister couldnt deduct hers in early 90s (at least that is what she complained about), I thought I remembered that mine was only deductible for a few years (I paid mine off since it was so small that I just wanted it gone.

 

[Nords]

I think we all know the traditional order of putting our money to use.  In other words, if a person has credit card debt @ 20% then he/she should pay that off first.  New scenario for me...

Suppose (as most of us expect) stock market returns remain moderate to low.  Suppose a person has quite a bit of student loans and/or other low interest debt.  If neither one is a clear cut best place to put money to work what should I do?

Any suggestions with before and after tax money?  Should I accumulate and then pay off student loan debt more aggressively when I get closer to a desirable retirement age? 

I think Roth IRA is a sure thing but beyond that I am not sure what to do....keep in mind I am pretty young.  Thanks as always.

This is like the mortgage reciprocated diatribe with lower interest rates.

First, be able to sleep at night. Could you carry that "huge" debt load and still be able to sleep? Could you set aside enough emergency funds to carry the payments (whatever the rules are) if you were unemployed for six months?

Assuming those feel-good answers are "Yes", then from here on out it's all math and I'm on Justin's side of the debate. If you can get more after-tax from the market than you're paying before-tax on the debt, then pay off the debt as slowly as possible.

First exploit all tax-deferred/free investments-- especially the coveted 401(k) match. So your 401(k) should be funded up to the match, then your Roth up to its limits, and then go back for the rest of your 401(k) (assuming it's not a high-expense plan).

Then run the numbers in FIRECalc. For the first set, assume you've wiped out your portfolio to pay off all the student debt. (Just like reducing your retirement portfolio to pay off your mortgage at retirement.) See how long your (smaller) portfolio survives your withdrawals.

For the second set, assume you have your current portfolio but raise your annual withdrawals to include the payments on the student loans. This portfolio will probably have a higher survival rate just because it's bigger (able to handle longer sustained downturns) let alone the fact that you're earning more from your investments than you're paying on your loans.

The keys to surviving three decades of this scenario are (1) cash flow (hopefully from salary) to pay the student loan and (2) having a higher return on your investments than you're paying on the loan, and (3) enough time in the market to handle fluctuations. With stocks this usually requires a couple decades, but with CDs or bonds it could take a lot less time. If you're earning 4% after-tax in a CD and paying a couple percent in student loans, you will win every time.

 

[wildcat]

Good advice as always Nords

 

[sgeeeee]

This is like the mortgage reciprocated diatribe with lower interest rates.

First, be able to sleep at night.  Could you carry that "huge" debt load and still be able to sleep?  Could you set aside enough emergency funds to carry the payments (whatever the rules are) if you were unemployed for six months?

Assuming those feel-good answers are "Yes", then from here on out it's all math and I'm on Justin's side of the debate.  If you can get more after-tax from the market than you're paying before-tax on the debt, then pay off the debt as slowly as possible.

First exploit all tax-deferred/free investments-- especially the coveted 401(k) match.  So your 401(k) should be funded up to the match, then your Roth up to its limits, and then go back for the rest of your 401(k) (assuming it's not a high-expense plan).

Then run the numbers in FIRECalc.  For the first set, assume you've wiped out your portfolio to pay off all the student debt.  (Just like reducing your retirement portfolio to pay off your mortgage at retirement.)  See how long your (smaller) portfolio survives your withdrawals.

For the second set, assume you have your current portfolio but raise your annual withdrawals to include the payments on the student loans.  This portfolio will probably have a higher survival rate just because it's bigger (able to handle longer sustained downturns) let alone the fact that you're earning more from your investments than you're paying on your loans.

The keys to surviving three decades of this scenario are (1) cash flow (hopefully from salary) to pay the student loan and (2) having a higher return on your investments than you're paying on the loan, and (3) enough time in the market to handle fluctuations.  With stocks this usually requires a couple decades, but with CDs or bonds it could take a lot less time.  If you're earning 4% after-tax in a CD and paying a couple percent in student loans, you will win every time.

Sounds familiar.

 

[laurence]

We paid the minimum on our student loans because after you figured in the tax break it was costing around 3% and IRA/401k accounts were a no brainer to beat that. Then we started to have the student loan deduction phased out on us due to our income (I know, nice problem) so we took out a heloc to pay them off - tax deductible again. Now interest rates are on the rise, and we are maxing 401k and IRA, and we expect equities to return sub par performances for a few years yet, so now extra dollars go on the heloc. We up the monthly payment about a hundred bucks every quarter and continue to monitor. I don't like variable interest loans, but so far this strategy has paid off, albiet by less than a %. At this point, it's only 30k, so if interest rates shot through the roof we could always scrape up the cash to pay it off.

EDIT: Holy cripes, I hit 1200 posts, and I've yet to say something significant! SG has only 1292, and I racked this up in what, six months? I don't have a problem! I can quit anytime! Just one more post!

 

[REWahoo]

I can quit anytime! Just one more post!

Fade in to a scene of two elderly ladies standing in front of a newly filled grave:

"That Laurence was such a nice man with a nice family. But what an unusual epitaph to place on his tombstone..."

REW

 

[sgeeeee]

. . .
EDIT: Holy cripes, I hit 1200 posts, and I've yet to say something significant!  SG has only 1292, and I racked this up in what, six months?  I don't have a problem!  I can quit anytime!  Just one more post!   

I hear your keystrokes at my back, Laurence. But I'm too old to care. I promise I'll go down gracefully.

Or we could start a fight about our IQs for the enjoyment of the rest of the board.

 

[KB]

No No....No more IQ fights

 

[wildcat]

Darn hijackers

 

[Patrick]

The keys to surviving three decades of this scenario are (1) cash flow (hopefully from salary) to pay the student loan and . . .

What happens if you default on a student loan?

 

[justin]

What happens if you default on a student loan?

It's like when you default on a loan from a loan shark. Except the government will get their money somehow, and you won't have your legs broken.