Question on best use/placement of savings

[Macaela25]

DH and I recently paid off all our CC debt and are left only owing for my car, my student loans, and a brand new mortgage. Our goal is to have an emergency fund (unspecified amount at this point) and to pay off my car. We have decided to pay the car before student loan debt since that percentage rate is higher and the interest paid on the student loan is tax deductible. I'm trying to decide how and where to allocate the money we do have where it will be used to the maximum potential.


Here's the scenario:

We currently have $5500 in our savings account. DH will be getting his monthly bonus next week, which will easily bump us up over $6500. I calculated that we need $3200 to meet bills and basic expenses per month (no donations to either church or retirement included there, since it would be considered for "emergency use"). So we will essentially have two months of emergency fund in place. I understand that is 3-6 months is recommended, correct? I also know that this money should be kept liquid, so I would think keeping it in savings is the best option. I have the option of my savings account becoming a "money market account" earning over 5% as long as the balance doesn't go below $2000. Is there a better option for maintaining the liquid emergency fund?

As for retirement savings, DH is currently contributing 4% of his income to company stock, and 4% to his 401(k) (matched 50% by the company) which is the limit for matching. I am rolling over my old 403(b) account into an IRA which I'll contribute at least $100 per month to.

We live pretty well below our income and usually have a good chunk of change at the end of the month to play with due to DH's commissions. I thought that paying the car loan off early would be a good decision. We are not anticipating another car purchase anytime soon. DH has a 2000 Honda Civic which great on gas for his long commute and runs very well - it's also paid for. I have an 03 Hyundai SUV with no problems that should last us awhile. We will be trying for a baby again in the near future, but the Hyundai should still see us through two children. Once we get #3 however (in probably 3-4 years) we will have to upgrade to a minivan due to space issues and most likely will trade in the Honda, which by then will be at least 10 years old. I would like to have a good chunk of money saved by this time to finance as little as possible.

Opinions? Suggestions? I felt that paying off/saving up for the car situation would take precedence over paying extra on our mortgage right now...we just made our first payment last week and 30 years seems like a very large black hole at the moment!! BzyBee DH, I am sure you will have some great advice for me on this one!

[berlinsmommy]

Do you mind posting the interest rates? I think they make a huge difference, for example, if the car is at 2.9% I'd treat it totally different than if it was at 10.9%.

[niftyneon99]

I keep all of our emergency money in Emigrant Direct. It's liquid, and earns like 4% interest or so.........but it is far enough away that I am not tempted to break into it and spend.

[iran2day]

I work as a financial planner and want to provide some insight. Warning this is long.

- I agree with you to not pay off the student loan early. Student loan interest is tax deductible. So long as your income level allows you to take advantage of this at tax time there is no reason to pay it off early.

- Typically, there is no fiscal advantage to paying off a car loan early. The finance charges are determined at the time of loan orgination and are not reduced (as they would be on a credit card or mortgage) if you pay it off early. You should check with your loan officer to see if your finance charge is reduced for paying it off early. If it is not, don't bother since you can use the cash more effectively in other ways.

[iran2day]

-Many people rush to pay off a mortgage. There is a tax advantage to having the interest when itemizing your deductions. Without seeing your taxes and speaking with your further I can't determine what the opitmal amount of interest is to make you as "tax efficient" as you can be. If you are good with numbers and have some patience you can do some number crunching and figure this out. Also a CPA could help you determine this. (PM me and I can help too). If you want to put some more money towards the mortgage I can empathize...just don't hurt yourself from a tax perspective.

- As for an emergency fund....3-6 months of expenses is the guideline. I always advise clients to add a little buffer in there for unexpected expenses like medical costs. It is best to keep this in a liquid fund. I would look at a money market account. It should be paying at least 4%. Some are as high at 5%. There are several online and your bank or credit union may have one. I know someone else mention emigrant direct. I happen to use ING direct. I would not use a CD since its not truly liquid. Remember to evaluate your expenses every 6 months to ensure your emergency fund is adequate.

- Keep up your efforts on the retirement savings. If you are fiscally able to do it maximize your IRA contributions to the limit. Also, definately roll your 403(b) into a self directed IRA. Some 403(b) have poor options for investing.

- If you want to start saving for a new car...you can always put some money into a money market or savings account each month and allow the interest to compound for you. Of course...you can do this once your emergency fund is up and running. Also once the emergency fund is complete...you can take the interest you earn each month and move that into a different account for the car. It'd be money for doing nothing.

- One other financial tool you can add to your family's portfolio....529 college savings plans for the kids. You can add a few dollars a month to it and allow it to grow. Also, they are great because you if the account is established for child #1 and child #1 doesn't use all the funds for schooling a new child can be named on the account and use it. It allows the account to benefit mutiple people. The child can be a neice, cousin, friend....it doesn't need to be your biological child. Some states have even started to allow a tax deduction for 529 contributions.

I realize this is a lot of material to digest. Certainly if you or anyone else has questions I am open to providing guidance. Oh and if you are curious I work in a full service financial planning firm. I am securities licensed, am a life and health insurance agent, and an accountant. I also consult on estate planning and administration matters so I have a wide range of experience.

--Catherine

[berlinsmommy]

- Typically, there is no fiscal advantage to paying off a car loan early. The finance charges are determined at the time of loan orgination and are not reduced (as they would be on a credit card or mortgage) if you pay it off early. You should check with your loan officer to see if your finance charge is reduced for paying it off early. If it is not, don't bother since you can use the cash more effectively in other ways.

YMMV on this. I have had a simple interest auto loan. Even making my payment earlier then the due date changed how much I owed. Check on your loan, if it is a simple interest loan then pay it off ASAP unless it has a low interest rate (lower then what you can earn on savings).

[iran2day]

Yes Berlinsmommy your YMMV that is why I said:

You should check with your loan officer to see if your finance charge is reduced for paying it off early. If it is not, don't bother since you can use the cash more effectively in other ways.

[BzyBee]

I work as a financial planner and want to provide some insight. Warning this is long.

- I agree with you to not pay off the student loan early. Student loan interest is tax deductible. So long as your income level allows you to take advantage of this at tax time there is no reason to pay it off early.

- Typically, there is no fiscal advantage to paying off a car loan early. The finance charges are determined at the time of loan orgination and are not reduced (as they would be on a credit card or mortgage) if you pay it off early. You should check with your loan officer to see if your finance charge is reduced for paying it off early. If it is not, don't bother since you can use the cash more effectively in other ways.

You may be correct in that there are 'benefits' to keeping student loans but IMO not enough to keep that payment dragging on for years.

We have a 'car payment' but it is owed only to ourselves...deposited into a mutual fund that earns interest instead of costing us. We don't work for it, it works for us.

Because we paid our students loans off years early we have been able to take that same money and invest it in retirement....we are now saving for our future, not paying for our past. We have more than made up for the tax benefit lost with the compounded interest on our retirement accounts. The house...that is getting paid early too.

You see, it's not all about the numbers. Everyone knows that money is tied to emotions, relationships and impacts nearly every aspect of our lives...it is more than numbers on a paper. That means you have to factor in benefits that you can't calculate...like the peace of knowing if DH lost his job that it wouldn't send us into a financial tailspin. Not having payments gives you that kind of peace. Or, knowing that if the kids come up short for a semester of college...we can cash flow it without being late for a car or mortgage payment. DH can QUIT his corporate job and do something that he enjoys more because we no longer need to keep his income high enough to make all the payments.

Those are things that just don't show up on a spreadsheet. I do understand that this is a different kind of financial philosophy...one that I hope you see has some valid points.

[BzyBee DH]

Great job so far.....

IMO - this is what I'd do -

I'd pay off the car, and student loans - try and do anything possible - to get rid of them within 18 months....

Then, with the extra cash freed up from those bad boys and the rest of your free cash flow - I'd increase my EF to 6 months of living expenses (not income, but your living expenses!).

Next, I'd start funding Roth to the IRS limits ($4k for each of you - this year, next year starts at $5k each)...Because you've already got your max matched 401k...Roth is the next best option.....

Then, I'd start a car sinking fund.

Now - specifics of the savings funds -

I use fidelity.com as there are a lot of mutual funds that are no-load, and have track records of earning above 12% for years.
I'd roll your old 403b account there.

You can use the research tool, select mutual funds, then pick >10% for 10-years....The list at the top are fidelity branded funds with no loads...I'd click on the "10-year" column - then you'd get a list of the top funds from a performace perspective from the last 10 -year....You can do the same for 3 years, or 5-years.

There are no fees (just expenses) on these with a $2000 min balance...But to be safe, I'd keep a $2500 balance in each...So next year's Roths - you each would have 2....
BTW - you can start these funds with a $200 initial balance as long as you contribute $200/month..you can stop with no fees once you get to $2500

Pick these 4 funds in different areas -

Most would make the first 4 - large cap, mid-cap, small cap & international
All stock mutual funds..You want these to be between 60 & 75% of your total portolio.

Eventually add a real estate, financial, bonds, etc....(this would be the balance)

You can open a mutual fund for your emergency fund (EF), car sinking funds, etc there as well. I keep about 50% in interest bearing checking type accounts, the other 50% in mutual funds.

Why this way?

Simple - I want to spend less, and save more...paying off debt makes me spend less, and frees up cash to save more....Plus as DW said, if I am carrying no debt, then my lifestyle expenses are a lot smaller - I need less invested to pay for my lifestyle.

We started in 2001 on this...Initially we were like you all now - student loan, car debt and mortgage...We had a total investment of 10% (including employer matching funds)...

By 2004 - paid off debts...started to invest more and find ways to reduce expenses.

2007 - Investment to 33% of total income (IRS limit max for 401k and Roths for both of us), and we are paying about 45% of take home pay on extra mortgage payments....(We are living on 1/3 of pre-tax income now - excluding investment and extra mortgage).

Plan - 2012 - paid off mortgage...I can easily retire with investments giving me double (or more) of my current living expenses. (kids start college, then)

Probably 2013-2018 - continue working, maybe PT - cash flow kids, etc -

Retire 2018 - investments paying 600% of current lifestyle expenses.

I think up until 2001, I was doing the "financial" thing...new cars with 0%, getting the deductions, etc...But my paycheck was used to the point I only had about 6% for investments....Getting rid of all debts (except mortgage) AND finding other lifestyle expense reductions (like couponing), have got us to this point.

I love the peace that we have now.

There are better purely "financial" systems on paper, but I like the peace of this one.

For some specific mutual funds right now -
FLVCX - Mid cap fund
FSMVX - Mid cap
FRESX - Real Estate fund
FSNGX - Energy fund
FSLBX - Financial fund

[kurlisola]

Typically, there is no fiscal advantage to paying off a car loan early. The finance charges are determined at the time of loan orgination and are not reduced (as they would be on a credit card or mortgage) if you pay it off early. You should check with your loan officer to see if your finance charge is reduced for paying it off early. If it is not, don't bother since you can use the cash more effectively in other ways.

We've had 6 or 7 auto loans in our lives & every one of them, if paid off early, then the interest was reduced. I've also worked in the accounting office at several car dealerships & though I never worked in finance & only glanced in a cursory fashion at the contracts, all would have interest reduced if paid off early (not sure how leases work, that might be different).