You have extra money (perhaps you got a raise). Your question: "Should I pay down debt or should I invest the money in the market?" The answer really comes down to the following: Are you able to generate an annualized return on your investments that exceeds your interest rate on your loan over the specified duration?
There are three principal factors that drive your "annualized returns" on your investments:
- the asset allocation (how is your portfolio divided up between different asset classes (stocks, bond, etc.)
- the market condition - how well does the market perform during the period of your investments.
- the duration
Use our calculator to enter these three pieces of data. This is a Google Sheets spreadsheet. The calculator is in read-only mode - so make a copy first (you will need to sign in to your Google account to do so) and then edit it appropriately.
The calculator has data pre-loaded in the 'Rawdata' worksheet. We got this data by running through tens of thousands of simulations of historical market data. We use S&P 500 index to model stocks, 3-month Treasury bills to model cash. We have modeled different stock allocations (0%, 10%, ..., 90%, 100%) and the balance is cash. (We do not model bonds in this simple model.)
You will see something like the image above for the scenario you have chosen (duration of loan, interest rate and market condition). You see a bunch of numbers like 3% (under 0) and 6% under 100. What does this mean? It means that when we ran our simulations, if you had 0% stock (100% cash), your compound annual growth rate was 3% over the specified duration. Because the loan had a 4% interest rate, simply getting an annual return of 4% in the market is not enough - better to continue to pay down debt. On the other hand, if you had 40% or more in stocks, then you got an annualized return of 5% to 6% - which is more than the 4% loan interest - hence, the dark blue color that says "better to invest."
Change up the scenarios is very easy - you will see something like the following:
Setting the Scenario Attributes
Specify the interest rate, choose the right value for loan duration (you can currently choose 5, 10, 15, ..., 30) years and specific market conditions ("Very Poor", "Poor" and "Average"). "Very Poor" means that the market performed at the 10th percentile (90% of the simulations yielded better results), "Poor" means 25th percentile (75% of the simulations yielded better results) and "Average" means 50th percentile (50% of the simulations performed better).
This does accommodate investment fees that may be levied - the fees are set at 0.75%.
Future work:
- Model taxes - this is tricky because of various factors (if home loan, then depending on your tax status and loan amount, mortgage interest may be deductible. Conversely, if you are taking the extra money and using it for your 401k, etc. then you may reduce your adjusted gross income (AGI) bringing down your tax burden.
- Ability for you to change fees and asset allocations.
If you have any questions/suggestions/etc. let me know.
Good luck!
Submitted June 15, 2018 at 05:45PM by arnexa https://ift.tt/2latYlX
