I am proud to say that I am now investing 15% of my own income into my work Roth 401(k) plan. I am forgoing my tax break now and going all in on my Roth 401(k) so I can live virtually tax free in retirement. My wife and I both max out Roth IRA’s as well. So you can see we’re heavily invested in Roth’s, and looking to the future for tax-free growth and tax-free distributions.
I am a big believer in Dave Ramsey’s 7 ‘Baby Steps’ and his philosophy on getting out of debt. My wife and I have been following his plan for a couple of years now and it has helped us out tremendously. Simply getting on a written budget did wonders for us and showed us where we can cut back to save money. Go figure! It’s so easy to do but a lot of people just don’t do a budget. It truly does work miracles.
Now that we are contributing 15% of our own money (not including company matches) into retirement, Dave Ramsey says to throw any extra money we have towards the mortgage. This I am struggling with because I obviously really, really want a paid-for home as soon as humanly possible. But at the same time I read a lot of conflicting advice that actually says you should continue investing that money instead or at least until your company 401(k) plan is maxed out at the $18,000 contribution limit.
Pay Off the House or Invest Even More?
I did some math to see how the numbers compare and they actually favor investing quite a bit more than paying down/off the mortgage. But having a paid for house is an intangible that you can’t really measure. This is where behavioral finance comes into play because who wouldn’t want a paid for home before the age of 45? So let’s crunch some numbers here and see what we get.
Through my home loans amortization calculator online, I found that if I want to pay off my mortgage in ten years and have the title of my home free and clear by May 2027, I would need to pay $1,200 more towards my principal each month. My interest rate is low at only 3.375% because we are a 20 year mortgage versus a 30. So these extra principal payments for the next ten years would also save me nearly $55,000 alone on interest, which is incredible. So in ten years I would have a paid for home and saved $55,000 in interest. Not too shabby, and that is a guaranteed return. The market doesn’t dictate that return for me and my family.
But what if instead I invested that $1,200 each month into the stock market versus my mortgage principal? Based off my previous post, experts like Vanguard and BlackRock are predicting the U.S. stock market to return only 6% annually over the next ten years versus the historical average of 10%. I know no one can predict the market accurately, but these are very respected firms simply calling for lower returns. I can respect that and use that in my planning over the next decade as I entertain the idea of investing even more for retirement or paying off my house.
If I invested $1,200 into the market for the next ten years and received a very modest return of only 6% annualized, like Vanguard and BlackRock are forecasting, I would end up with approximately $190,000. That amount is very appealing, even when compared to a paid for home and $55,000 in mortgage interest savings. To add to that, let’s assume the Vanguard and BlackRock respective forecasting reports for the next decade were too conservative and instead of 6% returns the market actually saw 8% returns. My $1,200 monthly investment compounded over 10 years at 8% would actually be worth $208,000. If they were wrong entirely and the historical average of 10% returns is achieved, then I’m looking at nearly $230,000.
Now you can see why I am torn on this decision? Because who doesn’t want a paid for house by the time they are in their early 40’s? But who wouldn’t want to invest with the prospects of earning $190,000 to $230,000? But the latter is simply that, a non-guaranteed investment. The $1,200 extra towards the principal of my mortgage is guaranteed to pay it off in 10 years. That return is 100% guaranteed. Therein lies my problem.
Buy a Home You Can Afford
It is a very simple concept. You must buy a house you can afford. Do so from the start makes an early pay off a possibility, whether you want do that or continue investing for retirement. Check out my blog post on home buying: Personal Finance 101: Buy a Home You Can Afford