Help a financial NOOB!

[BMXTRIX]

First to make the determination whether it is better to keep your money and invest it vs use it to pay off the mortgage, you have to use the 'risk free' rate of return. The only things considered risk free are short term fixed income investments (not bonds as they carry interest rate risk - as rates rise, bond prices fall and vice versa). It's easy to say you could earn 12% in a stock or mutual fund investment but they are not risk free by any means and you could easily lose money over the time horizon of the mortgage.

Fixed income investments are taxed at ordinary income rates. If you are in the 28% tax bracket and your mortgage interest is 7%, you have to earn 7% / (1 - .28) = 9.7% to BREAK EVEN. Is it so simple to earn 9.7% interest risk free - not at all!

Now if you feel like taking on risk to earn more than 9.7% and can deal with the potential for loss, then so be it, but if things don't go your way you will be in the hole. You also need to figure in property taxes and the deduction from income taxes you get for paying property taxes, so it really isn't so simple.

This is actually part of why a home loan is such a solid way to go. As risk free isn't the case at all, but historical trends and averages over time do tend to be serious market indicators for expected average annual rate of return. Considering you may see thousands of dollars in tax returns due to interest and that if you are investing long term then quite often taxes can be differred, you actually can be seeing, with very moderate risk, 12%+ rate of return quite easily. If you had an extra $200 a month to put towards your home your home may be paid off that much quicker...

But, if after your home is paid off, you invested the mortgage amount PLUS the $200 a month, at the end of 30 years you would still be behind, by a good bit, of what you would of had if you had simply invested the $200 a month directly for the full 30 years. On the other hand... Not having to drop $1,400+ a month on my mortgage (not including tax/insurance) sure would be nice.

 

[philh]

Clint,

That advice is absolutely fantastic and should be must reading for all college sophmores.

Wish somebody had given me that advice years ago.

Phil

 

[abboudc]

Hi, I'm poor But I'd like to change that.

Can anbody explain how I would go about building a (small) portfolio with a limited initial investment (maybe $500), followed by small monthly amounts (say $100).

I know its not much, but I assume anything is better than nothing, especially after a few years.

Check out the book "Finish Rich" by David Bach. The gist of it is living frugally now (don't buy a $2.00 cup of Starbucks when you can get a .70 cup of Wawa coffee) and instead sock that money away into investments. It's a worthy read.

Clint gave some great advice, save up an emergency fund, then 401k, then Roth. These are tax deferred investments that can grow much faster. Your "investment mix" will depend largely on your age and goals. If you have longer term investments, a stock heavy mix will pay the most dividends long term. As you get older, start shifting more and more of that money to safer, lower return investments like bonds. Consider meeting with a financial planner. Most investment companies will give you a free consultation and advice.

One more note: Don't overtweak your investments. I've seen the market have one or two bad weeks, and people re-engineer their 401k. If you're touching your investment mix more than once or twice a year, it's too much.