Emotions can lead wise investors to make decisions that are otherwise irrational. As financial advisers, we see these emotional decisions creep into an investor’s habits and decisions regularly. Sometimes, it makes a significant difference in their financial outcome, while othertimes it just defines who they are as investors.
For example, let’s look at an investor who maxes out his 401(k) contribution. On the surface, this is a prudent saver who is active in preparing for his retirement. Our investor contributes so much each pay period that he reaches his contribution limit eight months into the year. Is it better to spread the contributions equally throughout the year? It depends on the assumptions you are using.
Contributing to your 401(k) is akin to dollar cost averaging your money into the market. You invest a set amount and buy more shares when prices are low, fewer shares when prices are high. This works best in a volatile market when prices fluctuate. On the other hand, if you have a growing market, the earlier you can invest your money into the plan the longer it can grow tax deferred. You should have a better return by doing so. This decision may be influenced by how confident you are in the stock market. However, there may be other aspects to consider. If your employer match is a percentage of your contribution up to a certain amount and calculated per paycheck, you could be missing out on several months of “free money” your employer is willing to provide. If your employer contributes a fixed percentage of your salary, it may not matter when you contribute.
Another common emotion-based financial move is the desire to pay off your mortgage before retirement. Some investors cannot stand the thought of debt, especially when they are not earning an income, but does it make sense?
Today’s mortgage rates are still historically low, between 3.7% and 4.5% for a traditional 30-year mortgage, and between 2.8% and 3.8% for a 15-year mortgage. Additionally, for most taxpayers’ situations, mortgage interest is tax deductible. On a $200,000 30-year mortgage with a 4.5% interest rate and assuming a 25% federal tax and 6% state tax, the deduction changes your effective borrowing rate to roughly 3.3%.
Now consider the long-term annualized return for the stock market. If you look at the 10-year rolling average since 1926, Large Cap stocks have an annualized return of nearly 10.5%. From a pure financial perspective, it is better to borrow at a low rate and invest your money at a higher rate of return. Generally speaking, you should come out ahead.
Still, for some investors, paying off the mortgage is an emotional decision that allows them to “sleep better at night.” No number of calculations or scenarios a financial adviser runs will let the investor feel better about carrying mortgage debt.
Again, there is another aspect to consider: the liquidity of your investment. Should you need your money, your stock investments are liquid, which allows you to sell and receive your money nearly immediately. A home is not a liquid investment, making it difficult to access the money you have invested in it. It can take from weeks to years to sell a house. Additionally, you can also sell a portion of your stock investments, whereas you cannot sell a portion of your home.
Your emotions can play a large part in how you invest. Most investors are guilty of allowing some bias to influence their decisions. If you find yourself guilty of letting your emotions influence your financial moves, a financial adviser can help you determine if you need to take corrective action. If you’d like to discuss your situation, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
