Parking a windfall (sort of)


Dave Rusin

I have a twin pair of financial-planning questions to present for opinions.

Case #1. Some old holdings have matured, and I have $40,000 in cash right now.
What should I do with it?

My financial life is in order: I have a stable job, high in the 15% tax
bracket. My kids are grown, I have no consumer debt, and I have a modest
retirement fund begun. (I will retire in twenty or twenty-five years.)

So I don't really need to do anything with this money right now; the wisdom
of my present choices will be reviewed in, let's say, 2018.

I do have about 15 years left on my mortgage. I still owe about $75K; the
interest is 3.875%, and the $600/mo payments are no problem for me. I don't
plan to move any time soon.

So here are some options which I present for your reactions.

a. I could put the 40K in the bank. Fifteen years at 1% or so, and I've got
a guaranteed 46K.

b. I could buy savings bonds. Right now, series-I bonds are paying 4.66%.
More precisely, I can get bonds whose rate of return is reset semiannually
to be (1.1% + official USA inflation rate). (The actual formula is a bit
more complicated but you get the picture.) For prognosticating, you may
insert whatever inflation rate you consider likely. Say, 2% inflation
makes for a total of 63K in 15 years. (But really, do you expect inflation
to stay so low for that long?)

c. I could buy some mutual funds. Since I already have some aggressive
mutual funds in my retirement portfolio, I would prefer something with
less risk for this particular pile of money. But still, with a 15-year
horizon, one ought to be able to buy into a balanced fund of some kind
and have a decent chance of earning a total return which annualizes out
to say 5% or 6%, right? Then we're looking at say 90K in 15 years.
(And remember, I wouldn't need the money for another 5-10 years after
that, so a poor performance through 2018 wouldn't be a catastrophe.)

d. I could pay down the mortgage. With that kind of money I can pay off
my mortgage in just five more years (without changing the monthly payments).
Then for the rest of the fifteen years I can simply bank those
six-hundred-dollar payments. That gives me something like 80K in 15 years;
a little more if I make an investment as in (c), although the bulk of
the money would in this case be in my hands only later in the time window,
so I would be less interested in taking risks at that time.

A problem with (d) is that it gives away what is probably a great asset:
money borrowed cheaply (compared to the historical averages). I distinctly
remember old folks being chastised in the 1970s and 1980s for paying
off their low-rate mortgages from the 1950s rather than making
reasonable investments as in (a)-(c). The _current_ investment climate
doesn't make investing seem like such an attractive option, but
fifteen years is a longish time, and I'd hate to be sitting around in
2008 or 2013 saying, "Boy, I wish I'd saved some of that 40K for
investing now!"

Well, there are four options. I would welcome other suggestions.

Before I turn to case #2, please try to advise about case #1.


Have you decided yet?

<makes coffee>

I'll wait.

<reads WSJ>

#2 OK. I have this "friend", whose situation is amazingly similar to
mine, in terms of life financial picture. The only difference is that
he doesn't actually have 40K and a 15-year mortgage. What he has is
an older mortgage which will be paid off in just over 5 years, making
the same payments as above. Since his old note is at 6.625%, he wants
to refinance his house now and has learned about loan rates down in the
incredible 4% range. The refinancing itself is a given right now:
this "friend" can for example opt for a 3.875% 5-year (balloon) mortgage
for $35K which will pay off his old note (plus closing costs) without
changing his payments -- he just finishes paying the loan off a couple
of months early now, and so can start a new savings program that much
sooner, as in option (c) above. It's like finding a thousand dollars
lying in the street.

What my "friend" is considering, though, is to borrow more, take the
cash back, and invest it. That would, effectively, give him 40K up front
to invest, making his situation identical to mine. So he's got the
same options, right? You would make the same recommendations for him
as you did for me in case #1, right?

OK, obviously case #1 is a ruse, because I know if I present case #2
alone, people would say, "Don't bother taking the risk; just refinance
the old note and start saving." That might even be the advice I'd give.
I just keep having this gnawing feeling that these interest rates are a
golden opportunity and I can avoid kicking myself in 10-15 years if I
just borrow extra now and invest moderately conservatively.
(It might be worth pointing out that the first time I thought about
buying a house was around 1980, when mortgage rates were 18%. I did
buy in 1987, with a 9.11% note which I have refinanced -- twice already --
to get the 6.625% rate I have now. I was positive the last time that
I would never in my lifetime see rates so low that I would consider
refinancing again. Obviously, I was wrong. Got to get a new crystal ball.)

So: do I finance a cash-back mortgage or not?
And if so, what would _you_ do with the extra cash?



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