In this segment from theMotley Fool Answers podcast,Alison Southwick and Robert Brokamp welcome Sean Gates to the show as they answer listener questions.
This time, the team considers the best options for a lump sum of cash when the recipient has already been doing all the right things financially. Should he pay down his mortgage or invest it -- and if invest, then where?
A full transcript follows the video.
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Alison Southwick:The first one comes to us from John in Pennsylvania. "I recently received a lump sum of money and am wondering what the best thing to do with it would be." Aside from mailing it to us.
Robert Brokamp:Of course.
Southwick:Motley Fool, 2000 Duke Street, 4th Floor, Alexandria, VA 22314. John writes: "My wife and I already have our emergency fund in place and are maxed out on our workplace retirement contributions and IRAs."
Southwick:"We also don't have any credit card debt."
Southwick:"We are debating whether to pay down some of our debt or invest the money. Our current debts are a mortgage at 3.375% and two cars (one at 2.49% and one at 2.99%). I know that investing the money would give us the chance to earn a higher rate than our debts charge in interest, but I also like the idea of getting a guaranteed return by paying off some debt. Thanks so much, and I love the podcast." What should John do?
Brokamp:Well, the first thing to do is look at the interest rates on the debt. Given what he has said about his financial circumstances, I'm going to assume that he can deduct his mortgage interest, which then says that maybe there's some value to keeping that debt. The rates are very low, so you'd think long term you'd be able to invest that money and exceed the rates of that interest. That said, there is a psychological benefit to paying off debt.
I was in this same situation where we got some money and we decided to pay off a car loan. But then what we have decided to do is the money that was going each month to the car loan is now going to go to our kids' 529. So we paid off the debt, but then we're using that as a way to put some more money in savings, as well.
Gates:And I think it's a case-by-case basis. There's studies that show that if you have a cash cushion, you're happier, so maybe having that money set aside in a retirement account or in an investable account (just knowing it's there, rather than locked up in a mortgage or in a car payment) is helpful. So there's a lot of different ways to look at it, but I think investing it, especially if you're young, is a good way to go, but you're never offbeat if you pay down debt.
Southwick:Sorry. I'm having a hard time figuring out what your answer is. Some people like to go that way. Other people like to gothatway.
Brokamp:If you were to base it just on long-term, historical numbers ...
Brokamp:... you'd have a higher net worth by investing that money and keeping the debt. The debt is crazy low. I don't expect the stock market to return that mythic 10% annually a year over the long term, but you'd still probably have more money by investing it. That said, if you feel better by paying off the debt, that's not a bad idea.
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