Investment VS Debt

Discussion in 'Economics' started by myminitrading, Jul 18, 2006.

  1. Why would you put extra cash into stocks, mutual funds or any other investment that has no guaranteed return, and carries such a rick of loss. When you could just pay down the principal on your mortgage and save big bucks.

    I guess if you have paid off your home and carry no debt stock investments is ok. But to take extra cash and speculate in the financial markets when you are carrying a 30 year mortgage @7.00% seems foolish. Paying down your mortgage is guaranteed savings.
  2. Not necessarily in the short haul. Suppose you're in the 35% tax bracket like me (isn't ALL of ET?). Think about the increased taxes from loss of the deduction. And about the lost investment income, even after taxes, from what what you took out of play for the payoff. More complex than it seems. Especially if your mortgage is way below 7%. Besides, I like living in a house bigger than I can afford. It's the American way!

  3. I think when you factor in the average appreciation of real estate and the added benefit of paying down your principal its a winning combination.
  4. Hahaha! Where I am "the average appreciation in real estate" is code for "the average increase in property taxes and insurance". I am depreciating rapidly, so it doesn't much bother me if my house doesn't appreciate. As I said, not a simple trade, especially with a 5% mortgage.
  5. The real reason to not pay down the mortgage is two-fold:

    1) The risk-weighted after-tax return on trading exceeds the after-tax cost of the mortgage. If you trade short-term, then the before-tax rate of return and the before-tax mortgage interest rate can be directly compared. That is, you must average 7%/year net gains to pay the cost of borrowing money the 7% because the taxes you pay on 7% returns from trading exactly cancel your mortgage deduction on the 7% mortgage. If you have any long-term trading (e.g., holding positions for more than a year or holding dividend-paying across the 121-day window around the ex-div date, then the situation is more complex and the rate of return on the trading can be lower that the mortgage rate and still be net positive after taxes. Note that this is equivalent to a trading on margin -- you're borrowing money to trade.

    2) You need liquid assets for other financial goals (emergencies, being-out-of-work, college, future major purchases, retirement, etc.). In seeking to maximize returns on these assets, you decide to trade. Obviously, the presence of any mustn't-lose-this money will drive one to be somewhat conservative with some of this capital.
  6. Ask a financial advisor who has noting to sell, and does not work for an investment firm. I doubt they will tell you to take excess cash and invest in the stock market, instead of paying down debt.

    Diversification of assets is wise, but first elimate all debt, then diversify.
  7. You need to differentiate between good debt vs bad debt. Good debt is investment debt that creates value. Mortgages, as well as student loans and business loans are classified in this category. Most financial advisors will recommend that people assume debt that is tax deductible or create wealth in the long run. The reason is that often debt must be incurred in the short term in order to produce wealth in the long term. When you see advisors talking about the need to pay off debt as quickly as possible, they are referring to bad debt. Of course, by this they are referring to high-interest credt cards or personal loans used to buy durable goods or depreciating assets. For example, using a loan to purchase a car or a computer. I really don't think the average person should seek to totally eliminate their debt before investing. With mortgage debt, the taxpayer who itemizes receives a deduction of interest for up to one million dollars in home mortgage debt and up to 100,000 of home equity debt. Furthermore, real estate taxes are deductible. Consumers just need to make smarter debt choices taking into consideration their current financial status. For those who can't make smarter debt choices, I highly doubt they can make smart investment decisions.

  8. What is it some 80% of americans have zero savings, and $8000.00 worth of CC debt per household.

    I think the good debt bad debt issue is a waste of time as the majority of americans are flat broke.

    I like the ole motto from my grandfather who lived thru the depression. Work hard, stay out of debt, save and invest wisely.

    It really is that simple.
  9. I don't think its as simple as that. You just need to compare the interest rates that you're paying to your return on investment on an after tax basis. Individual circumstances will vary and you also have to factor in whether additional investment will create or destroy diversity.

    FWIW, I don't have a lot of faith in financial advisors. Maybe the rich ones, but I don't see many of those. Yes, they can help you to lead a secure existance, but I've found that most that I've met are not adept at wealth building, and are very averse to anything other than stocks. You ask about diversification, and they talk about other types of stocks, or stocks from other countries. (Hey, if you read my other stuff, you'd know I'm a real estate bull...but it is from this perspective that I saw this). What happens when all the baby boomers stop buying stocks, sell stocks, and cut consumption? All those stock markets may stagnate.

    To give you an example, at the point that Bill Gates was worth $10 million dollars (like back in the 1980s), I'm willing to bet that if he went to a financial advisor they would have told him, "You've got too much tied up in Microsoft stock and you need to diversify...sell all but 10% of it and buy stock from other companies". See what I mean? You can't point to one VERY wealthy person who didn't get there by taking a big, undiversified, bet. Now, if you're getting up there in age or something...sure...diversify like crazy!

  10. What about education? If a person gets into medical school, should they not go because they will incur a debt of 150 - 200k even though this will pay for itself many times over in the long run? The same goes for business too. I just think your view is too simplistic. The reason the american consumer has large amounts of credit card debt and zero savings is due to their own poor choices. There is a difference between using a credit card to buy a new music system and taking out a business or student loan. I have actually seen people use high-interest credit cards to purchase candy bars and soft drinks. Stupid people will always be poor and have nothing to show for it. That doesn't mean that all debt is bad.

    #10     Jul 18, 2006