Pay down mortgage or buy stocks?
Question: I have several thousand dollars in savings and wonder whether I should start buying stocks again or think about my mortgage. My broker is recommending some stocks, but I’m not sure after losing a lot of money in the market. I want to retire in a couple of years, and still have about 15 years left on my mortgage.
M.D.,
Chicago
Answer: Though it sounds like you are wondering whether stocks are a good deal, that’s not particularly relevant to your situation.
Because you are planning to retire soon, you cannot count on stocks to make up for losses in your savings. Predicting what the stock market will do over a couple of years is impossible, even when stocks seem like a sure thing.
But there are two moves that will provide more certainty about how you will survive in retirement. Make sure your savings will match your retirement living expenses. And pay down your mortgage to increase the likelihood that you will be OK in retirement even if your investments let you down.
The first step is one most people skip because it seems overwhelming. Looking into the future before retirement is not difficult if you go to www.360financialliteracy.org. Click on the “life stages” link and then the “retirement” link. Scroll down to “retirement planning basics,” and click on the “personal cash flow work sheet” to calculate projected expenses during retirement. Then use the “retirement income calculator” to understand how your savings will last into your 90s.
“Seriously consider delaying retirement if you can’t retire debt-free,” said Denver financial planner Charles Farrell.
If you don’t have to pay a mortgage or other debts, you can survive on substantially less in savings than if you have large required expenses. And if the stock market tanks for a long time, you can cut back spending, giving your stocks a chance to recover.
Farrell cautions people about thinking they can count on a part-time job in retirement to cover the mortgage. In this environment, there is no job certainty.
Aside from the calming effect of having your home paid off, financial planners suggest that paying off a mortgage is a good investment now. They compare the value of paying off a mortgage with the value an investor would derive from putting that money in a low-risk investment.
In this environment, it’s clear that someone about to retire isn’t going to make more money investing safely than paying off a mortgage, Farrell said.
Compare a 5.5% mortgage with a five-year bank certificate of deposit yielding less than 3% or a 10-year U.S. Treasury bond yielding about 3.5%.
Do not compare the 5.5% with what you might make in the stock market. Stocks are risky -- nothing you can count on in a short period of time. For younger investors, it makes sense to divvy up money between riskier investments such as stock mutual funds and home payments because over 20 or 30 years stocks are likely to earn a better return.
Some retirees think they should keep making mortgage payments for the tax deductions. But Park Ridge, Ill., financial planner Gary Bowyer said retirees often are subject to low tax rates, and avoiding mortgage interest is a better deal than the deduction. Even without a mortgage deduction, you can claim the standard deduction on taxes -- $11,400 for couples this year.
Regardless of what they do with their mortgage, Bowyer said, individuals about to retire should have about four years of emergency savings that are easy to access and safe. For example, if you calculated that your retirement living expenses would be $4,000 a month and that you would get $3,000 from Social Security and other sources, you should make sure you have easy access to $1,000 a month without touching stocks in a downturn. Bowyer suggests that individuals have $36,000 to $48,000 in an emergency fund possibly invested in CDs.
The rest of the investments could be divided roughly 50% in stock mutual funds and the rest in bonds. Bowyer suggests some Treasury inflation protected securities, or TIPS, among bond holdings to cut inflation risks.
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