As you probably know, I’m not an advocate of market timing. Jumping in and out of stocks is usually based on fear – either fear of missing out on hot returns or fear of more losses. However, if you’re going to do it, I figure you should announce your move beforehand, as opposed to making self-congratulatory pronouncements afterwards. “I sold all my stocks and my houses in 2007, right before the crisis hit as I knew something was fishy.” You never hear “I sold most of my stocks in 2009 and missed the potential doubling of my money since then.”
This is the predicament where I am today. I don’t think the stock market is very attractively priced. I don’t think locking up 2% yields for 10 years is a very good option either. Everything seems to be up, and our investments have swollen significantly. So while I’m not complaining, from what I can tell none of the things that were previously broken in the world have actually been fixed.
In addition to me being “meh” about the current investment outlook, having a new child has refocused us on shifting into part-time work as opposed to going all-out towards a full early retirement. Having the house paid off will free up our cashflow needs significantly, as our mortgage remains over 50% of our total spending. Once that is taken care of, it’ll be much easier to shift into part-time work as we want avoid using daycare as much as possible.
So for the rest of the year and probably into 2013, I am going to focus on putting new money towards paying down the mortgage. (Our 401ks and IRAs are maxed for 2012, and our current portfolio will stay invested.) This will effectively gain us a yield of 3.25% (our mortgage rate) for however long it takes to pay it off completely. Yes, we just refinanced this year, but we actually netted a thousand dollars from that refi due to negative points. Today, the S&P 500 Index is at about 1,435 and the 10-Year Treasury yield is 1.66%. Let’s see how wrong I can be. 🙂
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So you will put nothing in your 401k for 2013? Nothing in a Roth? How long will it take to payoff the mortgage with this strategy? It is tempting and I often think about doing the same. I also worry about high inflation that would make paying down a 3% mortgage look like a bad idea in hindsight.
I’ll probably still do the 401k for the match and also I can’t really lump-sum that one. Undecided about IRA, but probably will still do it if I see a good entry point.
I’ll targeting a year to payoff the mortgage actually, if market keeps going up or rates keep going down, I might sell some stocks and/or bonds.
I also bounced around with the same feelings about a 3% mortgage, I do think it may work out as a good rate to borrow at long-term, but in the end I don’t need any more leverage in my life.
This doesn’t sound like very extreme market timing, so I don’t think you should be too ashamed. 😛
If I understand you correctly, the sense in which you’ll be “timing the market” is by *not* investing in the market whatever sum which you *would have* invested in the market. Is this an annual thing? In other words, is there a specific sum which you usually invest in the market each year, but which you’re diverting to paying down your mortgage this year?
The reason your plan doesn’t sound like very extreme market timing is that usually timing the market entails buying or selling based on the belief that prices will be higher or lower in the relatively near future. But what you’re doing is just refraining from buying (but not selling) based on the belief that prices will not be higher (but not that they will be significantly lower) in the relatively near future. So it’s a very mitigated form of market timing, if it counts as market timing at all.
I agree, its mostly just a call that I think the market will drop from this point, although the total eventual bet size is relatively small, maybe only 10% of current portfolio. (In absolute terms, still a nice chunk of money.) I think both stocks and bonds don’t have much upside, so I’ll just keep the existing portfolio in buy-and-hold-and-rebalance mode.
Just saw this (http://www.bloomberg.com/news/2012-10-15/goldman-joins-wall-street-firms-in-seeing-s-p-at-record-in-2013.html) and was wondering if you think all these firms are wrong.
While I generally agree that the market is priced accordingly or even over-priced, I doubt you will see a steep correction. In fact, you may even see a bubble in the stock market before anything else. The simple reason is this: Where else would people put their money? As you said, bonds at 2% signifies that people/government have already piled in, so there is not much room to move lower (and make money off bond funds). People are gun-shy to buy houses and will be for a while (even assuming they have the money to do so). Gold has already skyrocketed. Usually when the market peaks, there is another investment/safety net for people to dump their money into (bonds, etc). I don’t see one this time around.
Your article is at the heart of what perplexes me the most. The market is obviously being propped up by nothing but hot air and yet, for the nimble investor there are clearly opportunities to jump in, make some money and jump out.
Personally I believe that there are two ways to make money. Either make money or not spend money and I think especially with only the insiders knowing what’s going on, your savings and debt reduction strategy make a lot of sense.
I’m sorry, I can’t really agree with this strategy. With interest rates so low and higher inflation likely over the next 15-30 years now is not the time to pay down a fixed rate mortgage at a historically low interest rate.
Yes, interest rates on the bonds you own are extraordinarily low and that is frightening. At this point I think bonds are a losing proposition over the next several years. I believe it makes sense to own short-term bonds. They pay next to nothing but will not lose value like longer bonds when rates move back up (which BTW I don’t think will happen soon but it will happen).
Yes, the S&P has come roaring back and it isn’t clear why. But on a P/E basis that index isn’t all that expensive by historical standards. Earnings have generally held up quite well even without very robust economic growth. The S&P isn’t cheap, either, more like average. International stocks (think Europe and Asia) are down significantly. Emerging markets also have been hit pretty hard. There are opportunities in a global equity portfolio at current prices.
I think you should lower your stock/bond mix to a level that you are more comfortable with for the next 10 years, because clearly you are not comfortable with the risk level in your portfolio now. Maybe shift your bonds into a shorter term fund because this is not an environment where reaching for yield is wise. Make sure you have a good mix of domestic, international, and emerging stocks. Then keep that mix, rebalance, and continue to invest.
If you are planning to stay in the house consider another re-fi with the goal of getting the payment down as low as possible. Lengthen the term and consider paying a couple of points to get a lower rate. Paying off the house would be nice but having the certainty of a low house payment could be just as good and I have to think you can get a better than 3% return in the capital markets. I think the long treasury bond is going to be paying two to three times that rate when the economy normalizes (within 5-10 years), because that’s what it has yielded historically.
The market will correct thru Dec, then it will roar to a new all-time high next year before the 5-year bull market finally ends.
Your follow-up comments lead me to think this is mostly about deleveraging and not about market timing. A somewhat less aggressive risk profile would be a normal financial response at the point in life where you have children.
One thing I hadn’t directly thought of in the payoff mortgage vs. invest debate until recently is that if you carry a low-interest (essentially at 0% real rate if inflation bumps up a bit like many expect) mortgage for a long time, it can affect your tax brackets in an early retirement or semi-retirement scenario. The higher % of total expenses your mortgage is, the more income you must realize later on and therefore the more tax risk you face. This is especially true with “Obamacare” and the 400% of poverty level cutoff for health insurance.
I made a similar decision almost a year ago, but it wasn’t to halt as much of my investing as Jonathan is doing. My portfolio and contributions to my portfolio are 70% stocks and 30% bonds, with the bonds split evenly between Total Bond Market and TIPS.
So here’s my version of psuedo-market-timing: While bond rates continue to be lower than my mortgage rate, I’m not contributing to fixed income investments at all, and replacing that with mortgage prepayments. On the inflation-protected side, I’m no longer contributing to my TIPS fund to earn a negative real rate, but instead buying I-bonds at 0% real rate. (My annual contribution to TIPS is below the annual I-bond limit.)
I still continue to contribute to my stock index funds with each paycheck, although at the moment not as much as in previous years only because we’re saving for a wedding.
You should max out your 401k in 2013 before increasing your mortgage payment, for example lets say you are in the 25% federal tax bracket, 5% state tax, 5.65% Fica (I am being generous and assuming the fiscal cliff is averted, that might be 7.65%). So for every dollar you earn you get to keep $.6435, however had you put the dollar into the 401k, you would keep 100% of it, that is 35.65% return, far better then the 3.25% you get on your mortgage. And you would not actually get 3.25% as you can use the mortgage interest deduction and your effective return would be 2.275% (70% of 3.25%).
As far as this being a market timing issue if you are bearish on the market you can always borrow the money back from your 401k, hopefully you can front load as most 401ks don’t allow for both loans and contributions at the same time, loan rates are generally prime +1%, currently 4.25%, and that is interest you are paying yourself. Then invest the money you borrowed by shorting whatever you feel is overbought, so perhaps an S&P 500 ETF or a total bond market ETF (bonds are probalby the next bubble anyway), you can short an entire asset allocation of non correllated assets to mitigate misjudging the market. If you are nto comfortable shorting you can buy long positions in ETF’s that are short the market, ProShares is probalby the biggest player in the short ETF’s. To make the play work you need to earn an after tax retrun of 4.25% to break even on the loan, but remember you are already ahead of the game because you are investing 100% of your contribution compared to the 64.35% had you not contributed to 401k in the first place.
A safer play is to pay the mortgage with the 401k loan which would be a loss of 1.975% based on the difference between the interest you owe on the loan vs the interest you owe on the mortgage but since you already made 64.35%, your total return is 62.375%, this way your 401k balance grows and you mortgage drops.
Just thinking out of the box on how to get a better return when returns are hard to come by. Prepaying a mortgage that is way below historical averages leaves money on the table, opportunity cost is expensive when money is so cheap right now there is no incentive to prepay, even though being mortgage free and having more cashflow can feel exhilirating.
It has been observed and acknowledged by many Market Gurus that one can seldom beat the market over the long run (SPX). People can be more profitable (than SPX) for a period of time but over the long run – buying and selling – does not generate the returns of what – buy and hold – generates. You can dedicate a portion of portfolio as “actively managed” and rest should be “passively managed and re-balanced”. Right now with interest rates so low, it does not make much sense to invest in bonds since it moves in the opposite direction of interest rates. However, that does not mean they will generate negative return considering dividend/interest they pay even though their price will drop.
When you pay off your mortgage your 1 year emergency fund will be oversized, have you considered using this surplus to pay off the last portion of your mortgage, or will you just hold a longer emergency fund or invest it elsewhere?
I think this sounds very smart. Market timing (all or nothing) can be pretty dumb, but factoring the current environment I think is smart. This is not an “all or nothing” move by any means, as you are heavily invested and will stay that way.
The kicker? IT will only take you one year to pay off? It’s not like this means anything in the long run (you are still invested, and will still be investing after this one-year hiatus). But it sounds like this move will buy you tremendous freedom. I’d absolutely make the same choice, especially given this interest rate environment. Of course, this would be an entirely different discussion if this was a 10-year-plan to pay off the mortgage.
Are you and your wife going to retire immediately when you hit 100% for emergency fund, mortgage payoff, and expenses replaced? Or are you looking for something like 150% of expenses replaced before retirement?
Also, are you counting your mortgage as an expense in this calculation? If so, wouldn’t your percentage of replaced spike up when you pay off your mortgage?
Sorry I entered the wrong numbers for the returns in the “safer play” paragraph,
The total return should be 35.65% – 1.975% for a total return of 33.675%
I apologize for commenting on something unrelated to this post. I have a question concerning credit cards (which you’re probably sick of!). I’m researching because I have a big trip next year and I want to take advantage of some sign up offers to subsidize my airfare. I’ve read that you regularly apply for 3-5 cards every 6 months. My question is regarding canceling these cards once you’ve decided you don’t want to keep them. How often and when do you cancel them? Do you try to cancel cards on a routine basis as well or is that not something that requires attention? Thanks so much for sharing this blog. In my opinion, you can’t have too many resources on how to handle money in a smart way!
@Andrew – Well, I don’t believe anything Goldman Sachs says in general, their focus is first making money for executives, then shareholders, and then on clients 🙂
@Erik – That’s the thing people are being pushed far on the risk curve with the zero-rate policy. Anything that makes yield is getting piled into.
@Andy – I hope you’re right, I’d love higher interest rates in my retirement years so I can lock in nice fat annuity 🙂
@aa – Another prediction! 🙂
@S.B. – Yes perhaps a better way of thinking of things. I could always invest in something and hope it would pay for my mortgage interest. I really want this mortgage gone, but realistically I wouldn’t pay it down if I could get a 3.25% dividend yield in the broad stock market (not just dividend stocks) or 3.25% interest on a investment-grade bond or bank CD (not just junk bonds).
If you itemize your tax return, the 3.25% mortgage interest you are comparing as yield baseline will be much lower. For example 3.25%X0.7=2.275%.
Also I am in a similar situation as your mortgage and considering paying down a few hundred more each month. What do you think of refi into a 15-year fixed 2.75% with no cost?
@Someguy – Good point about tax brackets.
@Dan – Sounds like a good plan to me. People say that you lose liquidity with mortgage prepayment, but really do you need liquidity if you’re just saving for retirement in the first place?
@Jay – Yup, gotta do the 401k for the match anyway. Also, be careful with those short ETFs, they only work in a daily basis and not well as a long-term short.
link
@J Bunch – Our expense replaced ratio is actually based on an estimate of future expenses needed, so excluding mortgage (which has its own ratio) but including things like property taxes and self-bought health insurance. If we reach 100%, we should be very close to being able to officially retire. I would note that the emergency fund is indeed based on current expenses, so that last mortgage payment will probably come from the e-fund as it won’t need to be as big anymore.
@Sarah – You may find this post helpful:
How Opening and Closing Credit Card Accounts Affects Your Credit Score
@Kevin – Yes, but any investment that I buy in a taxable account would also be subject to taxes, which basically makes it a wash.
I like no-cost refis if they are truly no cost and lower your payment. Why not? 🙂
Jonathan –
Thanks for sharing. This is very information. If you have time, I would appreciate a tip for one newly-embarking on the road towards financial security:
I agree with your general assessment that the stock market has likely realized most of its post-Recession gains. At the same time, as a recent graduate with limited debt, I am not yet at a point where I can sink my earnings into a home. (For practical reasons, it will not make sense to do so for a few years.) Does it make sense for someone like me to continue contributing to the 401k and Roth IRA as close to the max as I am able? Is there a better place for my money at this time? I’d like to save for a down payment on a home, but other than the 20k I can pull out of a Roth (if purchasing jointly), and maybe some bonds, I can think of no other way to ‘invest’ safely financially for that future purchase.
I appreciate your thoughts.
Tom
We are pretty much in the same boat except we have already paid off our mortgages. We are not market timers either – but quit regular investments outside of our 401K equivalents several years ago. Our best investment in the last couple of years hopefully will be a house we bought our of foreclosure with cash. Since we are facing college expenses and expect to retire in a few years, our main focus is to save cash, mostly in the credit union, for any additional college expenses we may face (already have a Pre-paid plan, education IRA, UGMA mutual fund, gifted savings bonds) or unforseen retirement expenses – nice not to have mortgage payments, stream of income from the rental properties that are paid off, and max sent to our 401K equivalents with some matching. Our credit union pays a slighly better interest rate than anything else around, and we are hoping that interest rates eventually go back up so that we can enjoy some interests from CDs/I-bonds in our retirement years.
Same here. Paying off that mortgage, investing in index funds and both working 4 days a week in order to enjoy life a bit more.
Interesting approach. I’ve been doing the same thing purely from a cash flow perspective as I believe I need to improve our free cash flow, not necessarily because I don’t think I can’t get higher rates of return elsewhere. I see you already have 74% equity in your house so it sounds like your close and you mention the cash flow flexibility is valuable to you as your mortgage is >50% of your expenses.
Do you have some sort of history/graph of your progress in your measurements? House Equity/emergency fund/portfolio? Hard for me to recall how quickly these have been growing for you.
i see why paying off the mortgage is attractive by freeing up cash flow; but, wouldn’t you be better off making the minimum payment and investing the rest in something higher earning? Not sure what your mortgage is (15 year 20, 30…) but the way i see it in 20 years my $2200/mo mortgage payment will feel more like $900 (accounting for inflation) so i’ll make my payments and invest the rest somewhere else where i can get a higher return over 30 years.
Can someone tell me if my logic is flawed?
Curious how you got cash on your refi with Provident. On their site they say “Any excess/unused credit will be retained by Provident Funding and not paid out as cash to the customer at closing.”
I’m still on the fence about using them.
@Mike – What happened to me was I paid something like $100 at closing but that covered escrow payments to the new mortgage which weren’t paid out yet (they always keep a buffer) and then refunded from the old mortgage. Sometime the amount you pay to pay off the old mortgage is estimated a little high, which also results in a refund of overpayment by the old mortgage lender.
You mentioned you want to avoid day care as much as possible. Is that for financial reasons only? My understanding is it helps greatly with child development/socialization.
I think you are failing to consider that your annual ability to contribute to a tax-advantaged account is itself a (wasting) asset. If you don’t put that money away in 2013, then decide to invest in later years with the “freed up” cash from a lower mortgage payment, and if your investments exceed your IRA/401k limit for that later year, the gains/dividends will be taxable to the extent of that excess. By paying your mortgage instead of contributing to a tax-favored investment account (even in a cash equivilent), you should factor in the additional taxes you’ll be subject to if in later years you end up exceeding those limits.
Dollar cost averaging (DCA) is the “cure” for the disease that afflicts most investors: buy high and sell low. As an index investor, if you can prove to yourself that you can stay the course during market gyrations (say, you continued to DCA in 2008-9), perhaps you don’t have the disease. I mostly DCA but when things look frothy, I increase cash-equivalents, and when there’s a drop, I buy. It’s a mild form of market timing but for those that can see market drops as opportunities (rather than head for the antacids), it can boost returns.
@mvp – Daycare does have socialization benefits, but dropping them off somewhere for 8-10 hours when they can’t even walk and they won’t get focused 1-on-1 attention is not ideal in my opinion. But rarely is everyone able to get what’s ideal. I think once they start to talk around age 3, we’ll definitely do some nursery school. Controversial new article about the benefits of Pre-K:
http://www.theatlantic.com/business/archive/2012/10/the-birthplace-of-income-inequality-pre-k/263809/
@Jason – I agree that tax-deferred limits are precious and expiring. The 401k will be done, and the IRA should be contributed to by the end of 2013 if all goes to plan. I’m not just in a rush – If the market tanks in between, I’ll contribute earlier.
Jonathan,
I like your blog. I like you; you however are making a mistake. You are letting emotions dictate when to buy and thereby abandoning a tenet of a long term investor. Discipline…staying the course in all market conditions. I don’t know what the market will do this year or the next (and I don’t really care) but I will be dollar cost averaging into it for the next twenty+ years. I do know that it will be higher in 30 years than it is today and I will not worry about the roller-coaster ride to get there. Pick your allocation; rebalance; and stay the course. You will leave upwards of 95% of investors in your wake.
Yup, I debate this one all the time… Pay off mortgage, or invest in something else.
My thought is, a big ‘ol loan at 3.25% is one heck of an inflation hedge. If we start printing money, I’d love to pay off that loan with cheap dollars. I find it hard to fathom that interest rates won’t get above 3.25% over the course of a 30 year loan.
Your line of thinking also mimicked mine in that I noticed you were looking at Dividend Aristocrats recently. (the Motif Post) Even if stocks are flat, if they can generate a 3.25% inflation rate it is a wash. I purchased DVY about a year ago for that reason. Considering utilities for that reason as well.
I would disagree with you in regard to “What good is liquidity?”
If I truly think the market is going to go down, the last thing I want to do is put excess cash into my house. Excess cash, as Buffett would say, is like having a free option on anything that drops in price.
That said, I did bend a bit and switch to a bi-weekly payment plan, which directly contradicts the advice above… Essentially an extra payment a year.
So yeah, you aren’t the only one who struggles with this.
Hi Jonathan,
I have been reading your blog for several years now and so appreciate your wisdom, experience, and transparency about your experience…even/especially when you know what you don’t know (if you know what I mean…). Congratulations on your daughter–that is priceless!
I would consider myself in a similar situation to you: big saver, fairly high income, generally ahead of the curve with what is already saved relative to my age (I am 37). As I, too, consider at what point early “retirement”/financial independence makes sense, I have wondered what your thoughts and preparations are for the stages at which the various “legs” of the retirement income “stool” kick in.
For example, I have determined (by using E$Planner–very useful!) that it will likely be best for us to begin withdrawing from tax-deferred 403(b)s and my SEP-IRA at 59.5 (because the balances will be relatively high and would likely eventually lead to a tax trap [pushing into high brackets & SS benefit taxation] if we wait until RMDs kick in).
Then, my wife will have a pension (probably small but likely around 40% of her income) that will be maximized for her begin receiving at 65 (my age 66.5).
It seems best for me to wait until 70 to begin collecting Social Security (in whatever means-tested form it will be at that point). (Who knows about my slightly younger wife who makes almost as much as I….)
So, we’re looking at the following time frames for withdrawing income from our portfolio:
Now (37) to 59.5: taxable accounts (if not earned income)
59.5 to 66.5: begin tapping my 403(b) & SEP
66.5 (wife is 65) to 70: begin receiving wife’s pension + above
70 to death: begin receiving maximized SS + all of above (+ Roth accounts which I would love to save as long as possible)
When we look at our whole portfolio from the perspective of withdrawing 4% (or your wisely conservative 3%), we might hit that mark in the next several years if we were to accelerate the mortgage payoff. However, looking only at the money available until 59.5 in taxable/non-retirement accounts (about 12.5% of our overall portfolio), we’ve got to do some serious filling of that pot to get us to “traditional retirement age”…and access to those accounts.
I would appreciate any thoughts or an article about your roadmap to and through each of those stages. Especially useful if, as I believe is the case, you will also have a HUGE pot of gold nearing the end of the rainbow (from maxing out retirement accounts)…but having a good number of miles to go in the meantime running on a relatively much smaller pot of non-retirement funds.
Again, thank you for a terrific blog!
Concur with Bradley’s praise of your site.
Here is my situation, and goals, and I am curious of your advice for our plan:
Our house is paid off. It is worth quite a bit, so we don’t plan on vacating anytime soon as the market where we live, abeit stable, is sloooow for sellers. I am in my early 30s, wife is younger, but we max our 401(k)s, ROTH IRAs (to the extent we can contribute), and are building a 6 month e-fund. With the additional $ we will accumulate over the next 5 years or so (assuming we maintain our earning power), I would like to purchase rental property near the local private college, and rent out to college students. This will create passive CF which I can use to create an “annuity” for retirement, as I will bank CF free and clear (I plan to purchase the townhomes with cash as it accumulated). This will also diversify our holdings (we are expecting to continue to max contribute to tax advantaged retirement accounts), and I am not big on investing in stock/equivalents in taxable accounts. Thoughts? Also, I enjoyed comparing our balance sheets when you used to update yours – any plans to bring this back in a monthly, or even quarterly, basis? Thanks!
I actually like the the strategy. I’m leaning in that direction as well, pay off the mortgage as soon as possible and get rid off the debt, regardless of the low interest rate. Financial planners will tell you you’re crazy to to be in a hurry, but I have 0 faith in their advice anymore. By the way, I am a market timer and do believe it possible to earn higher return on your investment by trading in the direction of the trend rather than letting your money sit through corrections and reversals.
Aside from what everyone above has said, being a modern portfolio theorist, the only question you really need to ask yourself is: “Are my indifference curves steep enough such that foregoing low-volatility leveraged arbitrage income at the future expected risk-free rate in order to lower my total net asset volatility by deleveraging now would place me on a higher indifference curve than not doing so?” If the answer is “yes,” then that’s fine. There’s nothing inherently wrong with having hella-steep indifference curves. Most peoples’ are flatter, but that doesn’t imply anything about whether yours should be.
Market tanked, Jonathan was right 🙂
So any regrets now that the S&P is over 1,700 and the 10 year treasury yield is over 2.6? I am still aggressively paying of my mortgage to be done in about 3 years but was wondering if you wold do anything differently?