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When money goals collide

Chris Farrell Jan 19, 2012

Question: We have achieved the goal of $10,000 in our emergency fund and now we’re looking to put that extra money into retirement. However, in this uncertain market with dwindling returns, we’re not sure that a long-term retirement fund is the best place to dump all our eggs. My husband is a professor and I am still in graduate school. We are in our early- to mid-30s and bought our first house in 2010. We have a fairly good mortgage rate of 4.75 percent.

Our question is: Would it be better to focus on paying off our mortgage early while the market is so volatile instead of putting all that money into retirement? Every penny paid off to the mortgage early is money we aren’t paying interest on, after all. Cathy, Bogart, GA

Answer: The markets are always unsettled, volatile and uncertain, even though the outlook is unusually murky at this time. Uncertainty is in the nature of markets. I would opt for taking full advantage of retirement savings, especially since most university professors have access to a good retirement plan.

I’m not a fan of homeowners putting too much extra money into their mortgage until they’ve built up a well-diversified portfolio. Otherwise, too much of their wealth and income is tied to one area (where they live and work).

The past isn’t prologue, but it’s indicative. In the past 60 years, the average annual return in the stock market was 6.8 percent. That compares to a miserly 0.4 precent return on housing. Basically, owning a home is a good way to build up equity (so long as you don’t take any out), but it usually doesn’t offer much of a return on investment.

However, there are some important wrinkles to your question to consider. I don’t know if your husband has tenure, but if he does, that can powerfully affect how you think about risk. A tenured university professor has incredible job security and his paycheck is essentially like a bond. He can afford to invest more of his money in riskier assets, such as stocks. (The same goes for government workers, K-12 school teachers, utility employees and the like. The more bond-like your income, the more you can afford to diversify into riskier investments.)

Tenure also has implications for thinking about accelerating payments on the mortgage. With tenure, the odds are high that you’ll stay put for a long time. You’ll also be confident of earning an income without spells of unemployment. These two factors reduce the risk of paying down the mortgage faster than the amortization schedule.

In other words, when thinking about risk, job security and job insecurity is critical. For instance, if he doesn’t have tenure and there’s a chance you’ll end up moving when you graduate, I would be wary of picking up the pace of paying off the mortgage. Your household income could fluctuate quite a bit. Instead, I would focus on building up savings.

Still, I would put a financial priority on funding retirement and then see where you stand.

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