Allocating our Limited Capital and my 8.27% Return
In the past 10 months that my wife and I have done an adequate job of limiting our expenses and accumulating capital in the form of cash savings. We are almost able to live off of one income and we have accumulated enough cash to pay our living expenses for 6 months in the event of an emergency.
We are now faced with the common question: “What is the best way to invest $5,000-$10,000 right now?”
This is always a difficult question because everyone has a different tolerance for risk and different end results in mind. Here are my choices this month:
- keep the money in cash earning less than 5%
- go with the higher historical average of the stock market
- take a guaranteed 8.27% return
I could keep this money in cash and sleep very well at night. This will likely give us the worst return of the three options but it also gives us the most flexibility. Our living expenses have fluxuated tremendously over the past few years and we continue to be dependent on 2 incomes to make ends meet.(just barely)
I will not be investing this money in the stock market. I came to this conclusion based upon the assumption that in 3-4 years I should be able to triple my retirement investments without the same level of sacrifice to our savings. I realize that I am approaching an age where I should be regularly contributing to my retirement and I will be kicking my self if the market races to 20% returns over the next 3 years. Since this is the first significant savings our family has been able to accumulate my primary concern is to not lose money on this investment.
What I will do is pay off my Private loan which has an interest rate of 8.27% This isn’t as sexy as finding a great stock that will go up 200% in the next 12 months, but it is the right decision for us at this time for multiple reasons.
- The most tangible reason for me is that this is a no lose proposition. I view good personal finance management as a series of good small decisions. By paying off this loan, I will be limiting my borrowing costs, decreasing our family’s monthly expenses and thus increasing our available monthly cash flow.
- The 8.27% interest rate on this loan is by far the highest interest rate on all of our liabilities. Our credit cards are at 0%, my consolidated school loans are at 2.85%, my wife’s loans are at 3.375 and my Federal loan is at 5%. Although some of our student loan interest has been tax deductible, the added benefit of this deduction does not outweigh the financing costs of this loan.
- With falling interest rates at this time, the benefit of carrying so much cash diminishes. I could reasonably expect the spread between the amount I am earning on my savings and this loan only to get larger as time goes on.
The deciding factor was when my loan holder sent my repayment schedule. I took one look at the image below and saw that if I took the full 10 years to repay this loan, I would have spent more on finance charges than what the loan was originally worth. Only by looking at the total cost of this loan and not the $100 montly payment does the true cost of borrowing this money become apparent.
Paying down debt isn’t fancy but its often the safest choice available. As a simple investor I will take the consistent 8% return this gives me. As our family’s finances become more secure I will feel more comfortable seeking a higher return.
