Have you heard this phase – Why keep playing the game if you already won? People are funny. We work hard and take risks to get what we want, but when we actually achieve our dreams, we can’t stop. Americans are raised to keep pushing forward to achieve more. Our culture values hard work and frowns upon idle hands. We find it really difficult to say ‘enough’ and be satisfied with life. On top of that, our consumerism environment is pushing us to accumulate more and more.
On Monday, I wrote about paying for a house in cash and got some really good feedback from many readers. BTW, this cash is from the sale of rental properties, so it won’t impact our retirement saving, emergency fund, or our dividend portfolio. Thank you for reading and commenting. I really appreciate it. If you haven’t seen it, you should check out the comments. It seems to me most people really fall into two camps.
- Security minded – Pay cash for a house and ensure a high level of financial security.
- Opportunity cost minded – Pay cash for a house and lose out on millions in stock market gains.
I want to take a closer look at the opportunity cost and see how much we’d really lose out if we paid for a house in cash.
Here is our fictitious home.
- Cost $500,000
- Mortgage $400,000 at 4% effective rate (after deducting tax)
- Monthly payment for 30 years is about $1,900
- After 30 years, interest paid would be about $300,000
Invest the lump sum in the market
If we get a mortgage and invest $400,000 in the stock market, then we’ll most likely get a better rate of return. Let’s assume 7% because I’d invest the lump sum more conservatively. At the end of 30 years, we’d have over 3 million dollars. That’s 10 times more than $300,000 that we’d save in mortgage interest!
Use the lump sum to buy a house
At first glance, the difference is huge, but don’t forget that we’d free up $1,900/month from not having a mortgage. If we invest that amount every month, we’d have about $2,250,000 after 30 years at 7% ROI. Add the $300,000 interest and we’d have about 2 and a half million dollars.
The difference is almost half a million dollars, but it’s really not as astronomical as I first thought. It’s about 15% and I can live with that.
Why keep playing?
Let’s get back to the why keep playing concept as it applies to retirement investing. When you retire, you won’t have a regular paycheck anymore and you will need to withdraw from your nest egg. Hopefully, you saved up enough to pay for 25 years of expenses. If you invest that money in safe treasury bonds, you will be fine for 25+ years. On the other hand, if you invest in the stock market, then a few bad years in the beginning of your retirement can be devastating to your nest egg.
Many people had enough to retire, but they continue to be overweight in equities. Some of them sold out during the financial crisis and never bought back in. This did a number to their nest egg and they have to keep working to rebuild their accounts. If they had invested in bonds instead, then they’d be able to retire.
The other option is to ride out the bear market and keep adding to your investment. Unfortunately, when you’re retired, you can’t do this because you won’t have enough income. Conventional wisdom says retirees just draw down their portfolio, right? When you’re near retirement, equities should be invested with extra money. The money you really need for day to day living should be invested in safer investments. You need to factor in social security and any pension as well.
Of course, most people haven’t saved up 25x their annual expense and they’ll have to take more risk on the stock market with their asset allocation. Working part time after retirement is another option.
Our Winning Plan
If we pay for a house in cash, our monthly expenses would drop down to around $2,200. The good news is that we already have enough passive income to cover this. The bad news is that most of it is in our retirement accounts. That’s fine though, because we aren’t planning to withdraw anytime soon. We are pretty heavily invested in the stock market with our retirement accounts.
Here is the winning plan.
- Buy a house in cash to reduce monthly expense
- Gradually become more conservative with our retirement account. In 20 years, the retirement account should be mostly invested in safe government bonds and throw off enough to cover our living expense.
- Extra money invested in stock market. We’ll use the money that we don’t have to pay the mortgage to invest in the stock market. This fund will be used for entertainment.
- Social security is gravy.
So that’s my plan. I feel like we are on our way to winning the game and I don’t mind giving up some gains. Sure, half a million dollars extra sounds tempting, but I don’t think we’ll need it. Meanwhile, we’ll have 30 years additional years of being debt free and I won’t lose as much sleep worrying about the stock market.
What do you think? Am I counting my winning too early? Should I stay hungry and keep on taking more risks?
Photo credit: Mike Baehr