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When Paying Off Doesn't Pay
http://finance.yahoo.com/expert/article/yourlife/37252 ^ | Friday, June 22, 2007, 12:00AM | Ben Stein

Posted on 06/27/2007 6:26:45 AM PDT by BenLurkin

was going to write a humor piece about the horrors of summer business travel, but after a spectacularly terrifying experience last night flying from Chicago to L.A., I decided I'd better put that in the "too awful to be told" category rather than the humor one for a while.

Instead, I'll deal with some frequently asked questions about finance, and personal finance in particular.

Plenty of Liquids

I get many letters asking whether it's better to pay off your mortgage or invest the money in the stock market instead. This is a complex question, but I'll offer several ways of thinking about it.

First, no one ever spent a sleepless night because she had millions in the bank and stocks but didn't have her home paid off. On the other hand, if you pay off your mortgage and deprive yourself of liquidity, you could be in for some miserable times.

As I see it, if money is even the slightest bit tight, hold onto it and pay off the mortgage month by month. There's nothing magically good about having a paid-off mortgage, but there's something seriously bad about not having ready liquid assets even if your home is paid for.

Slow and Steady

Yes, I know you can refinance and borrow against your house. But that takes time and creates aggravation. Why not just pay off the mortgage slowly but steadily and hang onto the liquidity that makes life so much more comfortable instead?

This is especially true if you're an older person. It doesn't do you one bit of harm to leave a home with a mortgage to your heirs. That's their problem -- and it's a very small problem.

It's far better in your later years to have cash on hand when you need it than to burn the mortgage note in the proverbial fireplace.

On Returning

But what if you can pay off the mortgage and still have plenty left for your liquidity needs? Even then, I'd think twice about rushing to pay off the mortgage.

As pointed out to me by my fraternity brother Larry Lissitzyn -- a very smart investor -- we earn, in rough terms, what the rate of interest was on a mortgage (not counting the immense tax benefit of the mortgage interest's deductibility) when we pay it off.

That is, if you have a mortgage with 6.5 percent interest, you'd earn roughly 6.5 percent by paying it off early. That's a fine rate of return and nothing to sneeze at. But the rate of return on broad U.S. stock market indexes over very long periods is closer to 9 percent -- a substantial difference.

Stocking Up

To be sure, there are long periods when the stock market doesn't return even close to 9 percent per annum. But it usually does, again on average and again over long periods. So you might be better off -- again -- just paying off your mortgage month by month and not taking the money out of the stock market.

On the other hand, if you have plenty of stocks according to your investment advisor and a huge surplus of cash -- which many people do have -- you might well want to use some of that to pay down your mortgage. A standard mortgage is now in the high sixes, and you won't get a risk-free return of that scale on any cash instrument I know of.

In short, unless you're sitting on surplus cash, I see no urgent reason to pay down or pay off your mortgage in a hurry.

Gold-Standard Advice

The second question I'm frequently asked is, Should I buy gold? I've never been a fan of gold as an investment. I know that since the early 1970s it's gone up from about $35 an ounce to (at one point) the high nine-hundreds. But it's also fluctuated wildly.

Gold has been "limit down" day after day in some bad periods. It dropped by almost two-thirds from the late '70s into the early '80s. It pays no dividends. And it's subject to attempts at market manipulation.

If you feel you absolutely must participate in precious metals I suggest buying gold jewelry, or else buying stock in highly diversified precious metals ETFs and mutual funds that combine many gold and silver mining stocks from all over the world. They fluctuate far less often than the raw material, yet they can grow dramatically if the metals rise.

Gold is lovely as a gift, then, but I don't see it as an investment for the ordinary citizen unless he or she is compulsively attached to its luster.

Trust Funds

Third, how do you play the falling dollar? Again, I wouldn't recommend speculation in the currency itself. That's far, far, far too treacherous for the ordinary investor.

But you can buy mutual funds and ETFs that own European, Asian, and Australian stocks, plus Canadian and South American stocks. These are usually denominated in the local currency. As it rises against the dollar, your investment is translated back into dollars and gets to be ever more valuable. Plus, you have the gain in profitability of the foreign stocks should there be any.

As I've said many times, I recommend the EFA ETF for investments in European, Australian, and Asian developed economies -- it's especially heavy into the United Kingdom. I recommend the EEM or the ADRE for investments in developing countries in Asia, South and Central America, and Eastern Europe. All of these have benefited greatly in recent years from the dollar's fall, and they do pay dividends, unlike gold.

The growth in value of these funds has been so immense that I wouldn't expect it to continue at anything like the recent rate. And there have been some serious fluctuations in the developing markets, even to a stomach-turning degree. But even if the EFA, the EEM, and ADRE grew at half their recent rate, you'd handily beat the Dow and S&P's recent moves. I wouldn't put most of my savings into these vehicles, but for a quarter to a half, you might consider it..


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To: Mr. Jeeves
Don’t misunderstand my comments. The absolute best is no debt and lots of cash (cash, stocks, bonds, etc). My whole point is that for the average person who is not financially independent, it’s much more important to have a healthy “cash flow” available to them from liquid assets rather than having all of their money tied up in an illiquid asset such as their house. If an emergency situation occurs such as loss of job or sickness, you don’t want to have to either beg to a bank to get some money back out of the house, or depend on selling the house quickly.
21 posted on 06/27/2007 7:16:33 AM PDT by AmericaUnited
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To: JamesP81

So you have a couple of years of tax monies set aside and then you get laid off, eating up that money in a flash. THEN WHAT?


22 posted on 06/27/2007 7:18:54 AM PDT by AmericaUnited
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To: AmericaUnited

Better yet, how about the person with no mortgage and still $200K in investments. This isn’t an all or nothing situation. A person can pay the mortgage off quickly, and not necessarily all at once and then free up their income to bank the equivelant of a mortgage payment.

Imagine that $250K mortgage, at a 15 year term, is approximately a $2,000 monthly payment. If that is 25-30% of the household income, the household should be able to pay that mortgage off very quickly. Just to be conservative, say they pay it off in 10 years and use the last 5 years to save. That leaves them with a paid off $250K mortgage and $120K in the bank.

Personally I am not very tolerent of risk, as a result I would prefer to be debt free and to get there I am being very focused. As a result, when I reach that target, I will also be very intense in my saving/investment. You might be more tolerent of risk, that is fine for you.

The problem is that folks read articles such as this and think that debt is OK, even tho they might be more aligned with my thinking when it comes to their tolerence of risk. In addition, it helps to cement the habit of accepting debt as a way of life, then they use that habit to finance anything and everything. Before they know it their monthly debt payments are higher than their income. The result is that they never get that $250 you talk about in the bank.


23 posted on 06/27/2007 7:20:19 AM PDT by CSM ("The rioting arsonists are the same folks who scream about global warming." LibFreeOrDie 5/7/07)
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To: CSM
Better yet, how about the person with no mortgage and still $200K in investments.

Well of course! But, for the average person, it much better to have a large chunk of liquid assets than a large chunk of illiquid" assets. Cash flow is king to weather through life's storms.

The problem is that folks read articles such as this and think that debt is OK

True.

24 posted on 06/27/2007 7:29:12 AM PDT by AmericaUnited
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To: AmericaUnited

“But, for the average person, it much better to have a large chunk of liquid assets..”

Except that I think the average person has no liquid assetts. Most people are spending more than they make. If they are focused on saving or getting out of debt, both scenarios are better than what is reality for most folks in today’s day and age...


25 posted on 06/27/2007 7:33:29 AM PDT by CSM ("The rioting arsonists are the same folks who scream about global warming." LibFreeOrDie 5/7/07)
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To: AmericaUnited
So you have a couple of years of tax monies set aside and then you get laid off, eating up that money in a flash. THEN WHAT?

A couple of things. Find another job if you can. If you can't, sell the house and buy a cheaper one. I personally wouldn't spend 200 grand on a house unless I could be assured a high return on that investment. I could buy a house for half that that would be more than enough for my needs.
26 posted on 06/27/2007 8:37:40 AM PDT by JamesP81 (Romans 10:9)
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