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Ask The Expert with Larry Swedroe, September 2008 Issue

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By Larry Swedroe, on September 10, 2008

Ask The Expert Larry Swedroe

This is the 9th issue of the Ask The Expert column by Larry Swedroe. You can see Larry’s full biography and important disclaimer below. If you are interested in having your question answered by Larry, please send me an email via the contact page.

Now, let’s get to the questions and answers (please note that the emphases and links are mine).

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Question from Dewey:

In the article by Larry Swedroe on Jan 9th, 2008, he stated that it probably best to pay off debt before investing in stocks. Does this advice take into account the initial tax savings from investing in retirement accounts such as IRAs, 401(k), etc.?

The answer is to do the math. You look at the after-tax return on your fixed income investments and compare it to the after-tax cost of the debt. Keep in mind that many people with mortgages actually don’t get the mortgage deduction because they use the standard deduction and others don’t get it because of the AMT. One should also consider that paying off the debt is a riskless transaction while unless your fixed income investments are backed by the full faith and credit of the U.S. government, there is some incremental credit risk that should be accounted for.

Typically what you will find is that the highest after tax return you can get (on risk-adjusted basis) is by paying off debt, especially credit card debt, auto related debt, etc.

One last point, if you have a fixed rate mortgage with a long maturity still left, and the math works out to be a small advantage to paying off the debt versus investing in short to intermediate fixed income investments then you might want to hold the mortgage because it does provide inflation protection. And that is worth something.

Best wishes
Larry

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  • Mr. Swedroe’s opinions and comments expressed are his own, and may not accurately reflect those of the firm, nor Moolanomy and its owner.
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  • The answer is given based on the information provided in your question. Please seek professional assistance for more personalized advice.

If you are interested in having your question answered by Larry, please send me an email via the contact page.

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Larry Swedroe
Larry Swedroe is a principal and director of research at Buckingham Asset Management, LLC, an SEC Registered Investment Advisor firm in St. Louis, Missouri. He is also principal of BAM Advisor Services, LLC, a service provider to investment advisors across the country, most of whom are affiliated with CPA firms. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management or BAM Advisor Services. Before joining Buckingham in 1996, Larry served as senior vice president and regional treasurer at Citicorp and vice chairman of Prudential Home Mortgage. Larry is author of The Only Guide to a Winning Investment Strategy You'll Ever Need (updated and re-released in 2005), as well as six other books. Most recently, he authored The Only Guide to Alternative Investments You'll Ever Need (2008). Larry has started his own blog called Wise Investing at CBS Money Watch. Please check it out!

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3 Comments

  1. gravatar
    Mr. ToughMoneyLove
    September 10, 2008, 12:21

    Nice article. Regarding the statement about a mortgage providing inflation protection, that is true if your income keeps pace with inflation. Otherwise your mortgage payment still represents the same percentage of your income, even if you are repaying with inflated dollars. For most Americans today, incomes are not growing with the rate of inflation.

  2. gravatar
    Larry Swedroe
    September 14, 2008, 10:36

    1) If you have inflation then you are repaying the debt with lower cost dollars in REAL terms. That is true regardless of other issues. So for example, over the long term your home, which is a real asset would likely appreciate in value but the mortgage payment remains the same. Again an inflation hedge (of course the mortgage rate has an expected inflation rate built in).

    2) If you have a fixed rate mortgage and fixed income assets and inflation rises then your mortgage stays the same but your fixed income assets will generate more income to reflect the higher inflation

    3) Stocks are also real assets and over the long term their returns should reflect higher or lower inflation. So you get higher inflation and your mortgage rate stays the same but you NOMINAL equity returns (not real equity returns) are likely to rise as well. Again, assuming you have stocks as well as your mortgage.

  3. gravatar
    Pinyo
    September 15, 2008, 10:29

    @Larry — Thank you for the clarification.

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