What should we prioritize financially with a surplus of money?
My wife and I continue to plan for our financial future. We are trying to determine what our best options are with surplus monies. Here are our options:
pay more off of our mortgage (4% interest); pay more off of a truck loan (1.99% interest); invest the money with our financial advisor (4%-9% return).
We have investments in low-risk stocks and bonds, but are still exploring a bit more in the stock market with medium-high risk stocks. I've recently opened a Scottrade account and joined Investopedia to expand my knowledge in this subject. But, we mainly go through our UBS financial advisor.
This should be a "lay up" for your financial advisor due to the fact that he/she probably has answers to some of the key questions one would need to make this decision. When it comes to debt reduction versus investment options, these sort of decisions are quantifiable, which makes them cut and dry. But there are key questions that should be addressed. In what stage are you in as it relates to your mortgage (how many years left and what amount is now going towards principal)? That information can be found on your amortization schedule. The same holds true for your truck loan. Normally, the ideal situation is to have the debt load rate significantly lower than your capital investment rate of return. That seems to be the situation here. But other factors to consider is whether you wish to increase your monthly cash flow by paying off some debt and reinvesting that new cash flow. Some forecasting may also play a role in the decision. If your advisor sees a pull back in the market, take the opportunity to pay off/down some debt, freeing up extra monthly cash flow, and dollar cost average you way back into the market.
Great question. A couple comments:
1) When you pay off debt, you know that you're going to get a "rate of return" on your dollars spent that is roughly the interest rate on the debt. Simply put, any unpaid debt you hold will grow by 4%/1.99% every year, so by paying off the debt, you're saving yourself that growth of an unpaid liability. While an investment portfolio certainly can outpace 4%, there is no guarantee that it will. Of course, your mortgage likely has interest expense deductibility for tax purposes, which complicates things slightly.
2) Be careful with UBS, or any wirehouse/broker-dealer, as they may be conflicted between doing what's best for their clients and what's best for the firm. Registered Investment Advisors, by comparison, are required to be fiduciaries for their clients. Firms like UBS may be dually-registered as investment advisors and broker dealers, which means that they can be a fiduciary sometimes and other times they may not. Your advisor is probably a good person and may be looking out for you before the firm, but just be aware of this. I'd be happy to provide a complimentary screen-through of the advice you've been given to look for inefficiencies or conflicts; feel free to ask if you like.
3) Scottrade is a solid custodian, and if you don't go with paying off your debt, I think you're just as good to put your funds here. With that said, as you continue to build your investment education and explore financial markets. I would recommend a couple resources to help along the way: "A Random Walk Down Wall Street" by Burton Malkiel and "Money: Master the Game" by Tony Robbins. If you're into audiobooks, let me know and I'll shoot you a link from Audible that let's you listen at no charge.
In any event, it sounds like you're mostly on the right path thus far. As I mentioned above, feel free to reach out if I can help further or clarify anything.
Adam C. Harding, CFP
Great question! First, I would ask, what would allow you to sleep well at night?
A few qualifying questions:
What's your net interest cost on mortgage after your tax deduction on your personal tax return?
Is the truck for personal use or business?
What's the current MAR ration, Max Drawdown risk of your portfolio?
Do you have enough cash in bank account if you or your wife lose a job and need to cover bills?
Where did you get your very optimistic return data from stock market?
How do you define low-risk? What did you do in the last recession?
These would be questions that we would discuss if we worked together. I hope these items expand your knowledge or least start thinking about how things might be in more difficult times.
There is no straight answer to your question. Financially, it appears better to invest with your financial advisor, but the outcome is not certain. On the other hand, paying the mortgage may give you peace of mind, which is very valuable as well. With regard to working with a financial advisor, I'd like to encourage you to understand the legal framework governing financial advice. Most financial advisors are either brokers or registered investment advisors. The brokers are regulated by The Securities and Exchange Act of 1934 that does not require them to act in their clients' best interest, in other words, they do not have a fiduciary responsibility to their clients. The registered investment advisors are regulated by The Investment Adviser Act of 1940 that does require them to act in their clients' best interest, in other words, they have a fiduciary responsibility to their clients. It may come as a surprise to you that 93% of all financial advisors out there are brokers who don't need to act in your best interest. All financial advisors from major banks/brokerages are brokers; thought not all brokers are from major banks/brokerages. The question to ask is, do you have a series 7 license?
The key to building wealth is decreasing liabilities and/or increasing assets, so debt payoff is definitely a good decision. Particularly, you should look to pay down/payoff depreciating assets first (e.g. truck). I advise clients to ignore interest rates [to determine the order to payoff] on debt in that it often clouds their judgment on how to view risk. Would you borrow money to invest in stocks? If not, then you shouldn't use surplus cash to invest in stocks when you have debts on depreciating assets to pay. Finally, not too long ago, a lot of people were proven wrong by thinking that real estate can only appreciate (e.g. 2007-2009). Therefore, you'd feel much better about the strength of your financial plan if you had little to no debt.
I use this hierarchy for surplus cash flow because it reflects the greatest tax benefits:
1) Salary deferrals to qualified plans because they reduce taxable income dollar for dollar;
2) Deductible contributions to IRA or HSA because they are above the line deductions thereby reducing taxable income;
3) Non-deductible contributions to Roth IRA, no deduction but tax-free growth on the investment;
4) Non-deductible contributions to Traditional IRA, no deduction, but tax-deferred growth on the investment;
5) Contributions to non-qualified accounts
I hope that helps!