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Investment choices after retirement funds are maxed out

First, pay off high-interest debt, then look at paying off mortgage

By Alan Klayman

Maturing Loans
Alan Klayman, creator of MyIncomeStrategy.com, is CEO of Klayman Financial LLC. He served as a vice president at Fidelity Investments, worked as a financial planner for American Express, and built fixed income strategies on Wall Street at The First Boston Corporation.

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Question for the CreditCards.com expert

Dear Maturing Loans,
I'm currently in a position where I have some extra money each year. After maxing out my 401(k) and Roth IRA account, I have about $40,000 to $50,000 to invest. My question is, should I be using this money to pay off my mortgage (15-year fixed at 5.375 percent) or investing in stock mutual funds?
-- Kevin

Answer for the CreditCards.com expert

Dear Kevin,
To review, you have a15-year fixed mortgage at 5.375 percent and an additional $40,000-plus to invest on an annual basis. You ask whether you should pay down the mortgage or invest in stock mutual funds.

Here are some of our unknowns:

•  Your age. More specifically: How long until you need to start to derive an income off of your assets.
•  Other investments in your portfolio.
•  Your investment experience and risk tolerance.
•  The balance remaining on your mortgage.
•  How you feel about debt.

So I will make a few different assumptions and see if we can nail down your scenario.

Here are some universal knowns for each scenario:

Your mortgage interest rate of 5.375 percent is low. With interest deductions that you may be eligible for on your tax return, this number may become even lower. What needs to be weighed is the potential earnings in a portfolio versus the reduction of debt service. For example, buying a bond that pays 6.5 percent tax free pays you more than the 5.375 percent (less taxes, say 4 percent) you are paying on your mortgage. In that case, investing in a fixed instrument that can service the debt is a good idea. Buying stocks (even mutual funds) has inherent risk, and this is a risk you must understand that you are taking. Your fixed rate mortgage is not changing, stock mutual funds have no guarantee. We know that historically stocks and stock indexes have returned in excess of 10 percent over a 10-plus year time horizon, but that is no guarantee for the future. Any investment in stocks or stock funds carries the risk you can lose money.

Step 0: Pay down any high-interest debt first. For example, credit cards or any other debts that carry an interest rate in excess of 5.375 percent and are not eligible for a tax deduction. This is step zero.

Scenario 1:
About to retire, significant investment portfolio, can tolerate risk, mortgage has 15 years left 

In this scenario, we know that you are experienced and can tolerate risk, but you are about to retire. What we need to do is to pick an income strategy, then calculate how much you need to retire on, how many dollars you have saved toward that goal, and then see if we need to add more savings and investments to it. If we do need to add to savings and are getting closer to retirement, then we would want to make sure your portfolio has an asset allocation (stocks/bonds/cash) that is in line with the number of years left to your retirement goal.

This is where your feeling on debt comes in. If you are uncomfortable carrying the mortgage, pay it down. The question of what works mathematically goes out the window when emotions come into play. If you are comfortable carrying the mortgage into retirement and you have a retirement income strategy that will cover this expense easily, then filling out your portfolio might make sense.

Scenario 2:
About to retire, not a lot of risk tolerance

In this scenario, paying down the mortgage might make you sleep easier at night. Investing in stock mutual funds would cause you to be up all night, on the Internet, scouring the paper ... not a lot of fun.

Scenario 3:
Long time to retire, significant investment portfolio, can tolerate risk, mortgage has 15 years left

If you have 15 years or so to retire and are willing to assume risk, then investing in a well-diversified, asset-allocated portfolio that is rebalanced at least annually can make a lot of sense. In 15 years you will have achieved both goals of paying down the mortgage and saving for your retirement.

Scenario 4:
Long time to retire, not a lot of risk tolerance, mortgage has 15 years left 

This is a tough one, because if you have any kind of reasonable market performance, you will pay down your mortgage and save a lot of money. If you do not have a lot of investment experience, I would suggest looking at a mutual fund that has a target maturity date. These funds start out more aggressive and as time goes on, they get more conservative. This could be a viable option for someone that has time, but not a lot of experience.

Another possible solution for this scenario is to do a little bit of both: Purchase mutual funds with targeted maturity dates and pay down your mortgage debt. Your CPA might want you to keep the mortgage, but again, if you can't sleep at night knowing you have that payment, you'd be better off getting a good night's sleep and saving for your retirement simultaneously.

I know there are a number of scenarios, and we only hit a few of them, but I hope you can see your situation in one of these four.

See you again next week with more questions answered.

Alan Klayman is creator of MyIncomeStrategy.com and CEO of Klayman Financial LLC. Klayman specializes in retirement income planning, business management and planning, estate planning, tax-advantaged investing, trust investment management, professional money management, insurance and annuities, mutual funds, fixed income securities, and institutional and personal retirement plan administration. 

Send your question to Alan.

Published: April 23, 2008


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