The 2016 market, my current financial picture and what to do with the tax-refund?

[dvalley]

Here's what my financial pic looks like today:
Age: 41
Investments: $380k (125k of this is in after-tax investments)
Cash: $50k (I'm single with a house and a kid so feel the need to have one year's worth of expenses in cash in case of a job loss)
AA: 70/30 (12% of the equity is Intl index funds)
Current savings/contribution rate: $35-45k per year
FI(RE) plan: Hoping to fire around 2025 (9 years) with approx $1.2M on the low side or $1.5M on the more comfortable side.
Current expenses: $55k per year. $27k of that is the mortgage which I hope to not have when I retire (I'll sell and relocate to a cheaper location if needed). Approx $200k in equity.
Future expenses in retirement: $50k per year
Current Debt: Mortgage and $8k remainig on one of the cars (1.9% financing).

2015 wasn't great from the investment return (mostly index funds) perspective even though I realize it's totally normal- as long as the market avgs 8% YOY from the big picture perspective. Let's hope!

Based on my rough calcs I should be getting about $8-10k in tax refund. In the past I've used tax refunds to put money into the house (new roof, appliance, minor updates etc) but don't think I have any plans for that in 2016 except may be a new water heater. This year I'm not sure if I should:

- dump the money into the market
- bump up the cash reserves in case of tough times ahead due to another market recession
- pay off the car loan
- put the money towards the mortgage principal

All thoughts, ideas or suggestions would be much appreciated. Thanks.

 

[eta2020]

All choices that you mention are sensible.
I would reduce my mortgage...

 

[rodi]

Why not do a bit of all of it... Put a lump sum towards the mortgage, toss some in savings, toss some in the market... and depending on the size of the car loan (and interest rate) throw some money there, too.

We're also getting a big refund (I think) because we pre-paid full health insurance premiums but will be getting back the tax credits. I'm in a similar quandary about how to spend the money - and will likely use some to fund future vacations, some to escalate some planned home projects (do them sooner than budgeted), and the rest back into the nest egg.

 

[sengsational]

I'd look at it this way...you're looking at increasing your after-tax balance by 6% to 8%. Fungibility of money, blah, blah.

If you were going to do anything with the loans, the refund shouldn't have anything to do with it (given you had loan payoff money anyway to the tune of $125K). I'd certainly keep a 1.9% loan! And I'd keep a mortgage of 4% or less if it's a fixed 30 or something like that, and you don't plan on moving. That's your inflation hedge...if inflation takes off, at least you'll pay off your house with those cheap dollars that were manufactured by uncle sam.

Bumping up the cash position is not something I'd do unless I felt really insecure about being able to earn money. Do you really think that you'd be out of a job for over a year? Shoot, I'd hire you just based on what I saw in your post.

If it were me, I'd put the money into my defined asset allocations. Not everyone has defined what percent of their savings goes into which investment vehicles (but everyone should, imho). If your AA does not include emerging markets equities, you might consider it. Interest rates are horrible for savers, so I wouldn't put any long term money in money market accounts...you'll simply lose buying power since the fed keeps interest rates so far below inflation.

The problem now is that you can't get a good return by loaning your money (bonds), and US equities are already bid up pretty high, based on historical PE ratios. I don't know much about 'em, but preferred stocks get some chatter around here. Kind of bonds but not bonds that give you a 6% yield. They'll tank if the economy hits the skids and they cut the dividend, but that might be an option for you.

 

[papadad111]

Pay off the car loan and any other non mortgage debt.

 

[dvalley]

All choices that you mention are sensible.
I would reduce my mortgage...

Pay off the car loan and any other non mortgage debt.

I was thinking along those lines too. My mortgage balance is $293k at 3.75%. My car balance is $8k at 1.9%. As much as I'd love to have one less bill, I was thinking of putting the money towards the mortgage since it's a higher percentage. I've been making a few hundered extra monthly payments for the past year and it's nice to see the balance actually visibly shrinking with each payment now. However, my biggest fear is always losing my job in which case I'd rather have $8k in cash so I can keep making the minimum payments if I have to. They won't care that I already paid x additional dollars towards the principal.

Why not do a bit of all of it... Put a lump sum towards the mortgage, toss some in savings, toss some in the market... and depending on the size of the car loan (and interest rate) throw some money there, too.

We're also getting a big refund (I think) because we pre-paid full health insurance premiums but will be getting back the tax credits. I'm in a similar quandary about how to spend the money - and will likely use some to fund future vacations, some to escalate some planned home projects (do them sooner than budgeted), and the rest back into the nest egg.

I just may do this, asset diversification - learn it, live it, love it

I'd look at it this way...you're looking at increasing your after-tax balance by 6% to 8%. Fungibility of money, blah, blah.

If you were going to do anything with the loans, the refund shouldn't have anything to do with it (given you had loan payoff money anyway to the tune of $125K). I'd certainly keep a 1.9% loan! And I'd keep a mortgage of 4% or less if it's a fixed 30 or something like that, and you don't plan on moving. That's your inflation hedge...if inflation takes off, at least you'll pay off your house with those cheap dollars that were manufactured by uncle sam.

Bumping up the cash position is not something I'd do unless I felt really insecure about being able to earn money. Do you really think that you'd be out of a job for over a year? Shoot, I'd hire you just based on what I saw in your post.

If it were me, I'd put the money into my defined asset allocations. Not everyone has defined what percent of their savings goes into which investment vehicles (but everyone should, imho). If your AA does not include emerging markets equities, you might consider it. Interest rates are horrible for savers, so I wouldn't put any long term money in money market accounts...you'll simply lose buying power since the fed keeps interest rates so far below inflation.

The problem now is that you can't get a good return by loaning your money (bonds), and US equities are already bid up pretty high, based on historical PE ratios. I don't know much about 'em, but preferred stocks get some chatter around here. Kind of bonds but not bonds that give you a 6% yield. They'll tank if the economy hits the skids and they cut the dividend, but that might be an option for you.

Ha, thanks for the kind words there. I don't know what made you consider offering me a job because for my age I feel I'm way off the mark with my networth. I have a bad divorce to blame for it but ultimately it doesn't matter the reasons what only matters is what I'm going to do about it and get back on track.

According to Personal Capital here's what my asset allocation looks like today for the investment portfolio:

U.S. Stocks = 60.03%
Intl Stocks = 12.32%
Alternatives = 10.13%
U.S. Bonds = 8.63%
Unclassified = 3.46%
Cash = 2.85%
Intl Bonds = 2.57%

I'm a little confused about your last paragraph "The problem now is that you can't get a good return by loaning your money (bonds)..." if the interest rate goes up as is being predicted for 2016 I would think the equities might take a dip but loaning money (CDs, treasury bonds etc) should give better yields than what we've been getting the past 3 years. I'm hoping PenFed etc bring back their 5+% CDs.

 

[sengsational]

What I meant concerning loaning money: I consider bonds, CDs, etc loaning money (as opposed to buying an equity interest in something (stocks)). There seems to be nowhere to loan money right now that beats inflation by a reasonable margin without a lot of risk.

There is nowhere for interest rates to go except up. So if you have short bonds, that's ok, but long bonds will take a beating. The problem with short bonds is that the rates nowadays will be artificially held below the rate of inflation, so they're a net loss on a real spending power basis. I have no domestic bonds. Instead, I have a large guaranteed income fund in my 401k. That looks like it's been beating inflation by at least a point.

I happen to think that the days where short bonds exceed inflation are gone. So just to tie inflation, you need to go long, and then you have a bunch of inflation risk. Western governments have massive debits that they're planning to pay off with inflated currencies because that's the only way out. But I digress.

For someone without a lot of job security that would feel better with a larger cash position, probably the best you could do is build yourself a short bond or CD ladder. It might not quite keep up with inflation, but by being short, you reduce the devastation that will happen to lon bonds when rates go up.

I agree with you that paying down your mortgage should not be a priority, both for the reason you mentioned (to keep the cash to keep paying in case of job loss), as well as the possibility that that mortgage rate might look awesome in the future if inflation takes off. And the 1.9% loan is a no-brainer: pay as agreed every month...the rate is lower than inflation so leave the money you would have paid it off with working for you.

 

[DrRoy]

A combination would be good, but for the pay down debt portion, go for the one with the highest interest rate. I would guess that is the car loan, but you should look at it from an after tax basis to decide.

 

[dvalley]

All valid and great points. I guess at the end of the day the question really is what to do with cash in 2016 whether it's $8k tax return or $80k inheritance. Personally my strategy has been when the markets are high I diversify amongst other asset classes including paying down loans (mortgage etc) because you're at least getting a guaranteed return. When the markets are down, I buy equities. So what I should do is stop the additional principal payments on my 3.75% mortgage and move those dollars into the market using DCA - oh and save 50% of the tax return money for the rainy day and the other 50% DCA into the market too.