A little while ago I was asked by Pete over at Bible Money Matters to answer some questions of his readers. This was one of the reader questions in regards to what to do with an inheritance.
Q: I was wondering if it is better to be completely debt free or to have some money in retirement. We have a mortgage where we owe about $170k and we also just got about $100k from inheritance. We also have about $30k in the bank. Should we just about pay off the mortgage or should we invest the money or should we do a combination of paying off and investing? My wife and I are 27 yrs old and the house is the only debt we have. Thanks, Josh.
A: Josh, thanks for your question. Coming into a windfall of money can bring on a whirlwind of emotions. First, I want to congratulate you and your wife for having level heads by focusing your efforts on paying off debt instead of going on a shopping spree. You are a role model for your generation. Let’s now look at your questions…..
Should you pay off the house or invest?
The phrase “debt free” definitely has a ring to it, doesn’t it? In your situation with your house being your only debt, I’m not sure that this is the best solution for your recent inheritance. Here’s a look into my logic.
Look Into Refinancing
A home allows you to write off your interest each year which can be a very nice deduction. If you qualify, I would make sure you refinance for a rate at least 6% or lower. If your rate is below 6%, one possibility you could look into is making an extra payment each year. Just by paying an extra $150/mo on your mortgage would save you thousands of dollars in interest.
Rethink Investment Strategy
Assuming you paid a good chunk on your mortgage and it freed up an extra $1000 a month, let’s see what that would do. If you turned around and invested that $1000 into an investment that averaged you 8% return, it would take almost 7 and half years to get you to $100,000 (and that’s not including taxes). You are better to keep paying the mortgage and adding more to your nest egg when you can. Just for fun, find a financial calculator online and see what $100,000 would be after 20 years by adding $200 a month and averaging 8% return. I think you’ll be amazed to learn what the power of compounding interest is all about.
I don’t know much about your retirement plan information; but if you qualify, one thing that you really should look at is Roth IRA’s for the both of you. The Roth IRA will give you both tax free money at retirement. Here’s some info on the rules of the Roth IRA for 2009.
Emergency Fund Looking Good
$30k in your savings is an excellent start for your emergency fund. Make sure you have somewhere in the neighborhood of 6-8 months of household expenses. Closer to 8 months if your job future is uncertain (maybe even 12 months). Double check and make sure you are earning a decent interest rate on your savings. I’ve seen many banks that will pay 0.25% (yes, there is a decimal before the 25) on their savings accounts. You could even consider an online savings accounts, but be sure to do your research.
Over and above that, consider a diversified portfolio. A portion of that portfolio could be a CD Ladder. Another portion could be investments that pay decent dividend yields. Since you will be in a taxable account, you will get favorable tax treatments on these types of investments. I don’t know your investment history, but if you are a beginner, there’s no sense diving in. By utilizing high yield interest accounts and a CD Ladder, your money will be making money while you educate yourself on your choices.
That’s some good information to get you on the right track. To receive an inheritance at such a young age empowers you and your wife to be in full control of your financial destiny, as long as you act smart. Based on your questions, it seems like you are on the right track. Be smart and trust your instincts on what money decisions you make.
Whether you are ready to invest because you received an inheritance, or you have saved up a nest egg to invest, Good Financial Cents is here to help guide you in the right direction. No start is too small, investing $1000 can one day lead you to investing 1 million dollars if you have a smart financial head on your shoulders and buckle down to secure your financial future!