Value of liquidity

[gadoc]

Question for everyone out there with student debt.  My wife and I currently have a combined income of close to 350,000. We are a dual income household. We finished residency 2 years ago and had close to 450,000 in debt. Have 1 small child. Because of this website we turned things around and have close to 200,000 in debt and are maxing all our retirement accounts.  I currently have about 50k in cash.  My questions is regarding the value of liquidity. Currently my loans are at 2.8% variable.  I am in the process of saving for a down payment for a house to buy and am hoping to have 150-200k saved in a high yield savings account. I am paying about 3500/month in loans. We were paying extra but have put that on hold for the downpayment.  Once I have 200k saved, that should be enough for a downpayment for a house and enough for an emergency fund I am wondering what the best bet is to do with my money moving forward.  I would obviously like to be debt free but not at the expense of not having any extra cash around for whatever may come up ( not emergencies ) With the current rate <3% I am leaning towards investing in index funds at vanguard/fidelity. If the variable rate exceeds 4% I would probably pay back the debt

I guess this comes down to investing vs debt repayment which I have read extensively on.  Even in 10 years if I still have debt but have amassed a solid amount in taxable accounts I dont see what the difference would be? Any opinions?

[Zaphod]

I would value liquidity extremely highly. I know I am in the minority on this forum, but it makes no sense whatsoever mathematically. Your rate is barely above inflation and you can easily get a better return putting that money to work even in a low savings or cd, though you have very stable muni funds to choose from as well with a similar return to your loan rate. Even then, you dont need the exact same rate of return for it to be better invested than paid down, given that loans are simple interest and investing is compound and the effects of inflation. The same goes for a mortgage, etc...

And best of all its not a permanent decision, if you decide one day you would rather have no debts, cash it out and pay it off, thats part of the value in liquidity...choices.

There will be a difference of opinion, but the math is clear, investing is superior in almost all regards (unless your rate is upper single digits) unless it just bothers you so...then you pay the premium, but you should realize it. If you're choosing between investing and paying extra, you'll also pay a tax penalty for the pleasure of doing so.

Think of it as paying down your debt with dollars that will be inflated away drastically (seriously, go to the cpi calculator page, sample graph attached) while at the same time not have that money growing at an average 30 year rolling return of 2500%, median 2100%, worst of 850%, best 6150%. Basically, you work really hard to pay an extra 1000 dollars today to save yourself having to pay 500 in the future while losing the opportunity to grow that to at worst 8500, and a median value of 21k. It really makes no sense, unless your job was insecure and unsteady or your overwhelming credit payments were so large you were living paycheck to paycheck (in which case it wouldnt matter, you couldnt pay down more anyway right?).

Doctors, no matter what we feel, have some of the most secure income and job stability out there, and we should recognize that and plan accordingly. Basically, we should do better at thinking and planning for the long term given the most likely scenarios and probabilities, and not overweight unlikely scenarios that do have a financial cost. Sure, you never have it so you dont notice it, but its still opportunity cost.

FWIW, when I was trying to figure it out (496k in student loans when started), I started aggressive with loan repayment only, but thankfully after a lot of due diligence realized it made no sense if the end result was similar (albeit with much more assets) if approached differently.

[gadoc]

Thank you Zaphod, that is exactly what I wanted to hear.  I understand debt is not good, especially close to 200K. It would be worse if we were big spenders and werent saving anything else as well, but we are not.  I'm not one that cares for emotions regarding whether or not a large loan is paid off. What interests me more is what is better mathematically.

Once I have the down payment for a house and a solid emergency fund I can probably put close to 8K a month into a 70/30 growth fund at vanguard.  This gives me options and i'd feel better having money around in case I needed it.  Obviously this may be more risky with a 70% stock allocation, but this money I dont expect to use in 15+ years.

 

This would be a pretty big shift in our current strategy. Every check we got almost all of it would go to debt repayment.

 

[Zaphod]

I do something similar, but use muni bond funds for the initial levels of funding and love that it throws off tax free income, its awesome. I would only say your plan is "risky" at low levels of funding (and that wont last long anyway), after getting it funded with about 150% (max draw down for a 70/30 portfolio being 30%) I wouldnt call your plan risky at all, just prudent.

Remember, in the end if you ever want to or need to suddenly pay something off you still can, its no big deal.

There is nothing "wrong" with debt, its just a tool, and as such can be used to build something like your career as a physician, or ruin your financial life. You've used it wisely, theres no reason to see it as anything other than what it really is.

As requested CPI calculator-http://data.bls.gov/cgi-bin/cpicalc.pl

Just a reminder though I dont find a 70/30 portfolio risky at all in terms of allocation, make sure your risk adjusted returns merit it in combination with your other accounts, that is, is your whole allocation 70/30 (aligned with your tolerance) or is just your taxable? My IRA is all stocks and my taxable 95% munis for the time being, making my ratio more like 55:45, but the taxable will grow much faster due to contributions and I may tweak it, but really not much need to.

[Hatton]

I agree that liquidity is extremely important.  I think gadoc that you are in your early to mid 30s. You are doing great with your debt repayment and savings..at 58 I am debt averse.  When I was in my 30s I put all extra money into the market. Times ha e changed in that I only had 30k of student debt (unbelievable right).  A good friend in finance made the points that ZAphod is making above. The first group I was with imploded early in my career. The liquidity that I had in the market gave me the psychological cushion that I needed to start my own practice. I paid my house off early just because I could.

[YYjames]

Agree with Zaphod.

[gadoc]

Now that i've decided to not pay off further debt and invest I guess I need to figure out how to invest properly.  Here is what I have currently.

 

My 403b,457 and my wife's 403b.  We max all 3 and with the match get close to 65k a year in this.  I am fortunate to have pretty good investment options from vanguard and fidelity and my asset allocation in these 3 is right at 80/20.

Now for the taxable account I plan on opening up.  My plan is to go with one of there life strategy growth funds with an allocation of 70/30 or 60/40.  I'm not an expert at investing and I am trying to read and learn about it as much as I can. Going with one of these " all in one " funds seems simplistic and easy enough to do. My plan would be to put 8k a month into this and just leave it alone for now. I am in my early 30's and once i'm older I can probably move the money to a lower risk fund. Thoughts?

What is this municipal bond fund you speak of and in what way is it tax exempt? Also is this is throwing off "tax free income" should I invest in this more?  Sorry as these questions are probably at beginner level but I am just starting to learn about this now.

Thank you all for the wonderful advice.

[Zaphod]

I would not do a target fund, the fees are simply too high but you could do a lot worse. Pick your allocation balance and then just use two low cost funds to do the same thing (vti/tlt, etc...). Its more important to just contribute, contribute, stick to the plan and let it grow, thats about as proper as it gets. Theres nothing wrong with more risk earlier on, but I totally disagree with the you can "afford" to take more risk because you're young motto. Its really the opposite, theres precisely no need because of that fact and any loss is magnified by the extended time period it could have been growing instead.

Municipal bonds are federal tax free, and if your state has income tax, there will be options for federal and state tax free muni bonds. These are great sources of income, but dont be fooled by the seemingly low yield, you have to apply your tax equivalent yield (what you would require to get the same if it was taxed as usual). I would look into it in your particular scenario (your marginal tax rate, state, income etc..) and decide if its a route you want to go either by adding some as your % allocation in that account or just a portion, up to you and your goals. At the vanguard fund site just check the tax managed or tax free box and you should get some choices.

All im saying regarding risk in portfolios is that make sure you are adequately reimbursed for the increased risk, which historically hasnt been borne out to the degree you would assume, ie, a 60/40 portfolio has performed much better than it should while giving you much less volatility and more predictable and sustainable withdrawal rates. This is beyond the scope of a comment to go much deeper I think. Remember, after all you have won the investing lottery by having a large income and ability to contribute a ton, you do not "need" risk to make up for your lack of principle. Youre not nearing retirement and just realizing you're way underfunded. We forget this (I constantly remind myself as well) in our desire to have it come together quickly rather than over the long term which is reality. I was once a 100% stock portfolio believer, but again, the data on risk adjusted returns simple were overwhelming along with the fact it was an unnecessary risk given I can contribute my way to a good retirement.

[lakelife]

Out of curiosity why not do the same thing with cars, boats, etc. I hear pay cash preached so many times but those interest rates are usually super low. Obviously the same math applies here so why not take the low interest rate and just pay it off over the period and invest the cash required to pay it off. Is it because these are depreciating assets? Or because the cost is usually something high income earners can save up for over a short period? This may just come back to how much debt one is comfortable with?

We are wanting to do some renovations on the house and I have been weighing saving up for it vs doing a HELOC for it.

[Zaphod]

I took my checkbook to buy my last car. They then offered me 0.9% financing, which of course I took since thats well below inflation and I am paying less than sticker price now. I try to view every transaction pragmatically and for best possible growth towards our goals.

Of course one could go crazy and have a ton of installment loans which wouldnt be good, or not be investing the money they otherwise wouldve used (which is usually more likely). However, thats not what most on these boards would likely do. For these cases, buying a car, paying off mortgage, etc...I think its good to build up a side account to that amount, and then decide whether or not to use it or finance, and if you finance you dont liquidate that other account just let it keep growing.

Obviously, you have to be careful not to justify to yourself expenses that make no sense and use that as a rationalization, which is of course the difficulty with everything.