Today’s question comes from Lindsey. She asks:
Thank you so very much for all you share regarding financial freedom and lifestyle choices! I am avidly reading your articles, and checking into your book suggestions (some I’ve read, some are new). I’m curious if you may have any input. I’m 40 and feeling a bit financially stuck and unsure. I’ve been “frugal”, financially responsible (debt free except mortgage, brief car/educational loans) and saved my whole life, but am realizing I may not be doing it most efficiently.
I’ve saved since I was little and started contributing to my 401k immediately at my first job at 20. Bought a small condo at age 27, and paid off the mortgage in 10 years. I did my best to save a lot, paying off the mortgage and in my 30s increased to the maximum 401k contribution (following stated aggressive portfolios). Not really living luxurious, just basic professional work life (only luxuries a gym membership, occasional work clothes, upkeep of car). That 401k balance is ~$300k which frustrates me, as compared to your charts, I would like to see it higher. I realize in my 20s I may have been invested in mutual funds with higher fees (1.x%), since my 30s am all in stocks or funds with very low fees (0.03%). In my 30s I also opened a Roth, contributing to that until income limits prevented me last year. In my 30s I did take a grad school fellowship abroad (which paid well, though I of course stopped contributing to a 401k those 3 years, rented my condo out, and saved for basics and a car when returning to the USA – was able to buy my car outright, and moved in my condo again). Recently I married, and we bought a townhome. We rent out my condo, and fingers crossed, that earns a small bit of income. I/we agonized renting vs. buying. We live in a high cost area, and it seemed buying (though now with a $580k mortgage) was possibly optimal.
I’m now in that same pattern of saving max toward 401ks (~$18k per year allowed per my understanding) and paying the mortgage off aggressively. The husband is less “awake or concerned financially”, though becoming more so over the years, and we still live frugally. He’s also debt free (beside a small car loan balance and small education loan balance). I have emergency savings to cover us ~6 months, in highest earning savings or CDs I can find (~1.5-3%). Though I’m wondering now, is it best to continue to aggressively pay off mortgage (was hoping for a 15 or 20 year end to this 30 year 3.6% fixed mortgage)? I know 3.6% fixed mortgage rate is relatively low, but with a $580k balance, the $21k per year interest eats at me.
Should I move half of the emergency savings to some sort of investment? I tried to learn about non-401k/IRA investing, but am scared/don’t know how to quite cross that boundary (and don’t have direct guidance anywhere). Just had a $10k 3% 5 month cd mature, and unsure whether to pay down mortgage or lean another way.
Thank you again for all you do in knowledge sharing & teaching! I wish I’d learned the basics you teach two decades ago!
You can put a dollar in your house or the stock market, and so your question is, “Where is the optimal place to put my dollar?”
It’s about opportunity cost, but there’s no “right” answer, just decisions with their own benefits and drawbacks.
For most people, paying off a mortgage early means sleeping better at night, but sleeping better at night means giving up the potential gains from investing in stocks.
Most financially savvy people will lock in a 30-year fixed mortgage at 4% when they have the chance. Why? They know 4% is “cheap money.” It’s a very low bar to hurdle when the long-term return of the stock market is higher.
In fact, this is the same reason businesses that don’t need to borrow money borrow money. They earn a higher return investing the money in the business than it costs to borrow. It’s the same concept for you and me.
Which reminds me of a story about a guy who wrote a check to pay off his $165,000 mortgage back in 2009.
If he’d invested the $165,000 in some boring S&P 500 index fund it’d be worth about half a million today, much more than his house is worth.
Plus, half a million can generate $20,000 per year forever based on the 4% retirement rule whereas a paid-off house forever costs money. Like Vicki Robin once told me, “A house is a place of consumption not production.”
Of course, it’d be irresponsible if I didn’t tell you the story is cherry picked. There’s been a historic bull market since 2009, and so every investor has made boatloads of money since then.
And that’s the thing: you won’t know if it was better to pre-pay your mortgage or invest in stocks until you look back 30 years from now.
But we have some clues to make a logical guess. Since 1926 the average return of the S&P 500 for all rolling 30-year periods was about 10%, with the worst being 8%.
So if you believe the future won’t be significantly different than the past, then even the worst market return will be about 4% higher than a 4% mortgage. Make sense?
This is where someone inevitably says, “Pre-paying a 4% mortgage is a guaranteed return, and 8% stock returns are anything but.”
True, there’s no guaranteed market return. And no guarantee you won’t buy stocks during the good times and sell them during the bad. Getting poor returns buying high and selling low.
In fact, that’s a great reason to pay off your mortgage early. If you know yourself well enough to know that you aren’t very good at buying stocks and waiting. If you aren’t a long-term investor.
If that’s the case, maybe it’s smarter putting money into your house. You get the peace of mind that comes from sleeping in a paid-off house, from being debt free.
If all that makes sense, here’s what the decision comes down to: you believe the market will earn a higher return than 4% and so you invest long term, or you want a guaranteed return and be debt free and so you pay off the mortgage.
Wait, one more thing.
I’d question your emergency fund. Only people living paycheck to paycheck need emergency funds. If an unexpected $400 expense causes debt.
You and your husband are working and living below your means. For a financial crisis — a job loss — you can momentarily stop contributing to retirement accounts to free up cash to pay the bills.
If both of you lose your jobs? Well, that’s another argument against pre-paying your mortgage. You can’t withdraw all those prepayments to make the mortgage payment, and if the bank doesn’t get their monthly check they foreclose.
In order to access the house equity you’d have to sell the house, and many people discovered that’s problematic if it happens to be in the middle of a housing crisis.
It will always be harder to get money out of a house, an illiquid asset, than out of the stock market.
Putting money into stocks means you’re able to keep making mortgage payments for a few months — if not years — even if those investments drop by 50% or so.
People arguing whether to pay off a mortgage early or invest in stocks is probably as old as time itself. There’s no right decision, because it comes down to what you believe and value.
Some people value the liquidity and higher gains that come from investing, others value being debt free and hate owing money. To each their own.