Personal Finance Financial Planning & Investing

[TexasBama]

Suggestion for those applying for a home mortgage:

The bad news is that the days of 3% 30 year mortgages are gone. Probably forever, certainly for a while. That cloud, however, has a silver lining.....

The value of extra principal you might pay is also much greater. That can help you own your home free-and-clear quicker.

If you're applying for a 30-year $200,000 mortgage, and the interest rate is 7%, your monthly principal-and-interest payment is $1,330 (Important Note: This does NOT include property taxes, insurance or any PMI).

You could pay on a 20-year schedule and the payment rises to about $1,550. If you can get really ambitious, and pay on a 15-year schedule, the payment is about $1,800

Now here's the thing not many people think about: You can have a 30 year note, but pay it on a 15 or 20 year amortization schedule. Then, if you have an emergency, you can drop back to the lower 30-year payment until the dust settles and you return to the original plan -- paying more than your contract requires.

Yeah, it hurts the first few months. Then it just gets baked into your monthly budget and you don't really think about it much anymore.

The huge advantage is that, if you pay off your 30-year mortgage after 20 years, that’s 10 years -- 120 monthly payments -- you don't have to make. In the case above, that's 120 x $1,330 = $159,600

If you can stomach the 15-year payment, that goes to 180 x $1,330 = $239, 400.

So you get the benefit of a shorter amortization schedule (that you created yourself), but keep the flexibility to go to the lower payment in case something unexpected comes up.

Aside from the increased monthly outflow, one downside is that 15 and 20 year notes typically carry a lower interest rate than a 30-year. But the difference usually isn't much, and to my mind is the price of the flexibility and peace of mind.

The other downside is that you have to have discipline, especially as regards the definition of an "emergency."

The kids wanting to go to Disney World isn't an emergency. Wanting a new F-150 Lightning isn't an emergency. The newest, baddest perimeter-weighted, godamighty carbon, adjustable aerodynamic whipsy-doodle driver certainly isn't.

Losing a job or getting sick or hurt and unable to work is. Fixing the transmission on your 6-year-old Ford, so that you can avoid buying a new one for a while longer might be (though you really should have an emergency fund for stuff like that).

And you have to do it every single stinkin' month. If you make the higher payment only when it's convenient, the whole thing falls apart.

Yes, it's hard. Yes, you sacrifice some fun and some toys. And for that reason, not many people do it. But Mrs. Basket Case and I did. And I'm telling you....when the mailman brings a thick envelope containing your cancelled note and mortgage, that is one of the most fantabulously glorious feelings in the world.

And then you have 10 - 15 years of NOT making mortgage payments injecting a bunch of newly freed-up cash flow into your monthly budget -- providing funds for both additional investment and some guilt-free fun and toys.

100% on this. I would argue further that paying off your mortgage is probably the best investment you can make. I'm pulling numbers out of the air, but I think this is reasonably close:

Say you owe 140k on your mortgage and still have 15 years. Your monthly is 1k. If you have 140k of after tax money you can pay it off with, thats 12k per year you're not paying. 12k per year on 140k is about 8.5% and its on an after tax basis. Find me an investment that make 8.5% for 15 years after tax guaranteed. You can argue perpituity, but if you're 50 or over it's close enough.

 

[Bamaro]

An article from the March 9 WSJ on the high costs of alternative investments and funds.

When Wall Street Rolls Out the Red Carpet for You, Who Pays? - WSJ

Unless you have a subscription, it'll be paywalled. The Cliffs Notes version is:
- Alternative investments and funds generate lots of fees for the broker: Upfront loads, high annual expenses, and often sales fees when you want to cash out.
- This eats into your returns to an incredible degree, and exponential math over years exacerbates the issue.
- The ones who win with alternative investments tend to be the brokers.
- They're really pushing these investments today because they don't make much money on index funds.

I also took away that right now, today, we're in a golden age of investing. Not because of high returns -- I don't think today's long-term returns for US stocks are any more or less than history shows. Rather because we can have a highly diversified portfolio for cheap and thereby keep far more of the long term investment returns for ourselves than our parents and grandparents could.

Here's the deal: Cheap index funds didn't become widely available until the mid-1980s. Before that, you had to build your own portfolio by buying a wide range of individual stocks. Because you had to buy 100 shares to avoid "odd lot" brokerage fees (much greater than the already-high fees for so-called round lots), and you had to do that for a whole bunch of stocks, it also required a pile of money beyond the means of most investors. And even if the investor could afford the purchases, he or she had to ride herd on that portfolio -- something beyond the expertise of most people.

Which is why, before Jack Bogle popularized the cheap index fund, individual investors viewed the stock market as much more of a gamble than it had to be. And they were right. Unless you have enough of them and are diversified enough for the law of large numbers to kick in, Individual stocks are a bit of a gamble. Contrasted with a diversified index fund which is far less volatile and much surer in the long term.

Bottom Line: Don't put your money into "alternative investments" unless and until you fully understand all of the associated fees and expenses, and understand the impact they will have on your return over years. It is highly improbable that you'll put your money into something that beats the long term risk / reward ratio of an S&P or Russell 2000 index fund.

Shouldn't that read Russell 3000, not 2000 since the 2000 misses the 1000 largest stocks?

 

[4Q Basket Case]

Shouldn't that read Russell 3000, not 2000 since the 2000 misses the 1000 largest stocks?

Excellent catch! You’re right, and I’m correcting the post.

Thanks for pointing that out!

 

[Bubbaloo]

100% on this. I would argue further that paying off your mortgage is probably the best investment you can make. I'm pulling numbers out of the air, but I think this is reasonably close:

Say you owe 140k on your mortgage and still have 15 years. Your monthly is 1k. If you have 140k of after tax money you can pay it off with, thats 12k per year you're not paying. 12k per year on 140k is about 8.5% and its on an after tax basis. Find me an investment that make 8.5% for 15 years after tax guaranteed. You can argue perpituity, but if you're 50 or over it's close enough.

Yes and no on this! If your mortgage rate is less than your current rate of return (i.e. savings/investments paying 5.0-5.5% and you've got a 4% or 2.75-4.00% mortgage let your investments grow! If the saving/investments rate of return decreases you can always withdraw the money for payments or to pay off the mortgage! In addition you are paying the mortgage with the depreciated dollar as your current dollar is at least partly keeping up with inflation. One size NEVER fits all.

 

[4Q Basket Case]

Yes and no on this! If your mortgage rate is less than your current rate of return (i.e. savings/investments paying 5.0-5.5% and you've got a 4% or 2.75-4.00% mortgage let your investments grow! If the saving/investments rate of return decreases you can always withdraw the money for payments or to pay off the mortgage! In addition you are paying the mortgage with the depreciated dollar as your current dollar is at least partly keeping up with inflation. One size NEVER fits all.

From a purely mathematical perspective, you’re absolutely right. And I see this argument a lot — if your mortgage is 3-4% and you earn 7-9% in the stock market, why would you pay your mortgage early? Use the cheap mortgage money to fund higher-earning investments.

There are three things here.

First, 3-4% mortgage rates are historically low. At the date this is written, they are no longer originated. It is unlikely that we’ll see that level of spread between long-term market returns and mortgage interest rates at any time in the future. It is highly unlikely that they’ll return anytime soon.

Second, you have to actually invest the difference between your low mortgage payment and what you would otherwise invest. And you have to do it every single stinking month. If you just spend it (and the reason for the spending doesn’t really matter), you defeat the premise.

Third,, you have timing risk. As in the stock market’s returns aren’t a smooth parabolic curve. It’s a sawtooth up. So if you have a 30-year mortgage and invest the difference between your payment and your disposable income, you can still have risk that after 15-20 years, you’re upside down due to expected variation in returns. It’ll come back…eventually. But not many people have the stomach to tolerate downturns and keep on keeping on.

So I 1000% see your point. But I wonder about prevailing market conditions and most people’s dedication and patience to actually execute what is undeniably a mathematically superior approach.

 

[4Q Basket Case]

Article from John Rekenthaler of Morningstar, naming specific domestic index funds that perform well. "Good performance" being defined as low tracking error vs. the index and low expenses.

The Best US Stock Index Funds | Morningstar

All of these funds are widely available through just about any broker you might use. I personally use Schwab, but for these purposes any will do.

 

[Bamaro]

Article from John Rekenthaler of Morningstar, naming specific domestic index funds that perform well. "Good performance" being defined as low tracking error vs. the index and low expenses.

The Best US Stock Index Funds | Morningstar

All of these funds are widely available through just about any broker you might use. I personally use Schwab, but for these purposes any will do.

Or invest in them directly.

 

[BamaNation]

Article from John Rekenthaler of Morningstar, naming specific domestic index funds that perform well. "Good performance" being defined as low tracking error vs. the index and low expenses.

The Best US Stock Index Funds | Morningstar

All of these funds are widely available through just about any broker you might use. I personally use Schwab, but for these purposes any will do.

Thanks 4Q !

As Jack Bogle frequently stated, "You get what you don't pay for." ...There's an extremely high correlation between long-term performance and lowest expense ratios. There's also a very high correlation between, say SCHB (Schwab's Total Stock Market ETF fund) and VTSAX (Vanguard's Total Stock Market Fund). Schwab, Fidelity, and Vanguard all have excellent total market/bond/int'l/etc. funds across the spectrum. The main point (supported empirically) is to avoid actively traded funds. Stick with passive. It's a key principle we've continually emphasized in this financial series.

As shown in the article, If you're paying more than 0.10% in expense fees for total market funds, you're doing it wrong!

As an aside, there may be some minor tax advantages in ETFs but if you do a long-term comparison, the differences even on large sums of invested money is relatively tiny. ETFs are bought/sold during the trade day at the spot price while mutual funds are priced at the end of the trading day. Read Rick Ferri's book on ETFs if you want the specific details. My wife hates ETFs because if price goes down 2 cents 5 seconds after buying, she feels like she lost money (same if she sells and price goes up 2 cents 5 seconds after selling). Me, I make the decision and just do it. She's more susceptible to behavioral economics than me so if there's a need to buy/sell an ETF (which might be the only option sometimes), then I do it.

 

[4Q Basket Case]

Outstanding article from Amy Arnott of Morningstar on how to diversify an investment portfolio and which asset classes have actually provided diversification over the long haul.

Top 10 Things to Know About Building a Diversified Portfolio | Morningstar