Investing For Dummies. Eric TysonЧитать онлайн книгу.
your mortgage faster, compare your mortgage interest rate with your investments’ rates of return (which I define in Chapter 2). Suppose you have a fixed-rate mortgage with an interest rate of 4 percent. If you decide to make investments instead of paying down your mortgage more quickly, your investments need to produce an average annual rate of return, before taxes, of about 4 percent to come out ahead financially. (Technically, this comparison should be done on an after-tax basis, but the outcome is unlikely to change.)
Besides lacking the money to do so (the most common reason), other good reasons not to pay off your mortgage any quicker than necessary include the following:
You instead contribute to your retirement accounts, such as a 401(k), an IRA, or a SEP-IRA plan (especially if your employer offers matching money). Paying off your mortgage faster has no tax benefit. By contrast, putting additional money into a retirement plan can immediately reduce your federal and state income tax burdens. The more years you have until retirement, the greater the benefit you receive if you invest in your retirement accounts. Thanks to the compounding of your retirement account investments without the drain of taxes, you can actually earn a lower rate of return on your investments than you pay on your mortgage and still come out ahead. (I discuss the various retirement accounts in detail in the section “Funding Your Retirement Accounts” later in this chapter.)
You’re willing to invest in growth-oriented, volatile investments, such as stocks and real estate. To have a reasonable chance of earning a greater return on your investments than it costs you to borrow on your mortgage, you must be aggressive with your investments. As I discuss in Chapter 2, stocks and real estate have produced annual average rates of return of about 8 to 9 percent. You can earn even more by creating your own small business or by investing in others’ businesses. Paying down a mortgage ties up more of your capital and thus reduces your ability to make other attractive investments. To more aggressive investors, paying off the house seems downright boring — the financial equivalent of watching paint dry. You have no guarantee of earning high returns from growth-type investments, which can easily drop 20 percent or more in value over a year or two.
Paying down the mortgage depletes your emergency reserves. Psychologically, some people feel uncomfortable paying off debt more quickly if it diminishes their savings and investments. You probably don’t want to pay down your debt if doing so depletes your financial safety cushion. Make sure that you have access — through a money market fund or other sources (a family member, for example) — to at least three months’ worth of living expenses (as I explain in the earlier section “Establishing an Emergency Reserve”).
Don’t get hung up on mortgage tax deductions
Although it’s true that mortgage interest is usually tax-deductible, don’t forget that you must also pay taxes on investment profits generated outside of retirement accounts (if you do forget, you’re sure to end up in trouble with the IRS). You can purchase tax-free investments like municipal bonds (see Chapter 7), but over the long haul, such bonds and other types of lending investments (bank savings accounts, CDs, and other bonds) are unlikely to earn a rate of return that’s higher than the cost of your mortgage.
And don’t assume that those mortgage interest deductions are that great. Just for being a living, breathing human being, you automatically qualify for the so-called “standard deduction” on your federal tax return. In 2020, this standard deduction was worth $12,400 for single filers and $24,800 for married couples filing jointly. Mortgage interest deductions now are also limited to mortgage debt of $750,000. If you have no mortgage interest deductions — or have fewer than you used to — you may not be missing out on as much of a write-off as you think. (Plus, having one less schedule to complete on your tax return is a joy!)
Establishing Your Financial Goals
You may have just one purpose for investing money, or you may desire to invest money for several different purposes simultaneously. Either way, you should establish your financial goals before you begin investing. Otherwise, you won’t know how much to save.
For example, when I was in my 20s, I put away some money for retirement/long-term financial independence, but I also saved a stash so I could hit the eject button from my job in management consulting. I knew that I wanted to pursue an entrepreneurial path and that in the early years of starting my own business, I couldn’t count on an income as stable or as large as the one I made from consulting.
I invested my two pots of money — one for retirement/long-term financial independence and the other for my small-business cushion — quite differently. As I discuss in the section “Choosing the Right Investment Mix” later in this chapter, you can take more risk with the “longer-term” money, so I invested the bulk of my retirement nest egg in stock mutual funds. With the money I saved for the start-up of my small business, I took an entirely different track. I had no desire to put this money in risky stocks — what if the market plummeted just as I was ready to leave the security of my full-time job? Thus, I kept this money safely invested in a money market fund that had a decent yield but didn’t fluctuate in value.
Tracking your savings rate
To accomplish your financial goals (and some personal goals), you need to save money, and you also need to know your savings rate. Your savings rate is the percentage of your past year’s income that you saved and didn’t spend. Without even doing the calculations, you may already know that your rate of savings is low, nonexistent, or negative and that you need to save more.
An important benefit of knowing your savings rate is that you can better assess how much risk you need to take to accomplish your goals. Seeing the amount that you need to save to achieve your dreams may encourage you to take more risk with your investments.
During your working years, if you consistently save about 10 percent of your annual income, you’re probably saving enough to meet your goals (unless you want to retire at a relatively young age). On average, most people need about 75 percent of their pre-retirement income throughout retirement to maintain their standard of living.
If you’re one of the many people who don’t save enough, you need to do some homework. To save more, you need to reduce your spending, increase your income, or both. For most people, reducing spending is the more feasible way to save.
