A reader in Georgia asks this question for his son: "He and his wife, both 31, have no debts other than a 30-year mortgage on their home...
A reader in Georgia asks this question for his son:
“He and his wife, both 31, have no debts other than a 30-year mortgage on their home purchased two years ago. They are contributing 15 percent of their combined total income of $130,000 to their respective employers’ 401(k) plans. “They estimate that they could contribute up to 25 percent to their 401(k)s, but instead they have been applying the additional 10 percent to paying down the principal on their home loan.
“Over the long haul, which alternative — increasing their 401(k) savings or principal deduction — should be their No. 1 priority?”
The answer depends on your age, your tax bracket and future inflation.
Most Read Stories
- 83-year-old woman sexually assaulted in SeaTac assisted-living facility; assailant sought
- What drivers can and cannot do under Washington state's new distracted-driving law
- Put down that cellphone; distracted-driving law is here
- Passage of paid-family-leave act shows power of working together | Op-Ed
- Homeless students drawn to Seattle schools by sports are often cast aside when the season’s over
For more than 50 years, American homeowners have benefited from borrowing as much as possible for as long as possible.
Until 1977, we borrowed at regulated interest rates that were barely over the rate of inflation. As a consequence, you paid back much less purchasing power than you borrowed. The result was a larger and more affluent middle class.
Even in the period that followed, when interest rates exceeded inflation, homeowners benefited from interest rates that were often below the appreciation rate of their houses.
(Note that this is not universal. There have been periods and places where home values declined. Homeowners in much of the Midwest and central parts of the country aren’t to be confused with homeowners on the East and West coasts. For some, homeownership has been like holding a winning lottery ticket.)
Many financial planners argue that you should be slow to pay down the home-loan debt because its net cost is zero when tax benefits are considered and that you can earn a higher return investing the money elsewhere.
I agree with the first part. I think the second part is cheap talk — easier said than done.
In fact, the most important issue isn’t relative returns — it’s financial strength.
That comes from liquidity and security. Both are important at all ages.
You can own your home free and clear, but if you have no other assets you may be forced to sell it if you lose your job. That’s why I measure financial security in staying power.
What’s staying power?
It’s how long your liquid financial assets — not money in your 401(k) — will support your current standard of living (and debt).
Surveys routinely show that most Americans would be in deep trouble within a few weeks of losing their jobs.
You need to have liquid assets — deposit accounts, money-market accounts and short-term fixed-income mutual funds — that will provide staying power. The longer your staying power, the better.
This is not entirely defensive. If you have staying power, you are more likely to be aggressive in wage and salary discussions.
If you don’t have staying power — if every dime of income is committed before your receive it and you don’t have any savings — you can’t argue very forcefully because you can’t afford to lose your job.
Bottom line: The priority for young couples is to build a staying-power fund, not additional 401(k) contributions beyond capturing their employer match.
Once the fund has been established, additional savings should go into longer-term investments based on safety, expected relative return and long-term goals.
A 30-year-old should build investment assets. A 50-year-old, on the other hand, needs to put emphasis on debt reduction because all but the most affluent should plan to eliminate debt service by the time they retire.
Questions about personal finance and investments may be sent to Scott Burns at The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265; by fax at 214-977-8776; or by e-mail at email@example.com. Questions of general interest will be answered in future columns.