"saving money won't make you rich"

[Lumination]

Thanks, I appreciate the in-depth response. I figured that path was the most sound, but it's a little soul-crushing to learn that index funds only become a "sensible" option once someone is already investing $6,000 into an IRA and $19,000 into their 401K each year. $25,000 annually is quiet the chuck of change! I suppose index fund-investing is hardly for everybody.

Click to shrink...

401k and IRA investing IS index funds investing, because you can put that money into index funds. Just think of it as your first $25k of index fund investing every year is tax-free.

Yeah, it's a big number, but it's meant to help you, so the bigger that number is, the better for us.

 

[Sheepinator]

Time in the market always beats timing the market. If someone will give you a 0% loan allowing you to leave an extra $20k invested for 5 years the smart thing is to take it every time. Doing that repeatedly over 30 years you win around 98% of the time.

Click to shrink...

There is a lot of truth in there, and it's good advice for people with plenty of assets and money. However, such talk diminishes the risk for those with less money. Take for example all those people who bought multiple homes around 2006 and 2007 with the easy money low interest loans, because housing prices could never go down, so they'd sell them for a nice profit before having to pay much on the houses. Those people were wiped out. That car loan of $5K people are talking about, let's say someone does that just before the market has a downturn. There is a near 100% chance (historically speaking) that over 5+ years the market will be higher than at the start of that period, but that loan doesn't get paid off at the end of the 5 years. It needs to be paid monthly. Let's take a hypothetical 1% loan for $5K, with a market that declines in the first 2 years then rises for 3 years.

A loan at 1% would be $85 per month, or $1,025 per year, total interest paid after 5 years of 2.5%. Let's say the market does this in 5 years:

-25%, -25%, +33%, +33%, +25%

Over 4 years the investment will have recovered to break even and over 5 years the original investment will be up 25%, which is far better than paying 2.5% interest. Hold on a sec though, that loan needs to be paid monthly. To keep it simple, I'll make it annual:

End of year 1: Investment now $4,000, pay out $1,025 to cover loan, have $2,975 left
End of year 2: Investment now $2,230, pay out $1,025 to cover loan, have $1,200 left
End of year 3: Investment now $1,600, pay out $1,025 to cover loan, have $580 left
Year 4: You're screwed, you can't pay off the loan, and you still have about a year and a half left.

If you have other assets to sell, other spare disposable income, etc. you can cover that and in the long term you'll be fine. However the fact that you need to sell investments or not invest that money in order to pay that debt goes against the original advice given here, but sure in the long run you'll likely end up better off. If you don't have other assets, you're screwed, you can't pay off that loan and you've lost a big chunk of your original savings.

 

[Deleted member 29676]

There is a lot of truth in there, and it's good advice for people with plenty of assets and money. However, such talk diminishes the risk for those with less money. Take for example all those people who bought multiple homes around 2006 and 2007 with the easy money low interest loans, because housing prices could never go down, so they'd sell them for a nice profit before having to pay much on the houses. Those people were wiped out. That car loan of $5K people are talking about, let's say someone does that just before the market has a downturn. There is a near 100% chance (historically speaking) that over 5+ years the market will be higher than at the start of that period, but that loan doesn't get paid off at the end of the 5 years. It needs to be paid monthly. Let's take a hypothetical 1% loan for $5K, with a market that declines in the first 2 years then rises for 3 years.

A loan at 1% would be $85 per month, or $1,025 per year, total interest paid after 5 years of 2.5%. Let's say the market does this in 5 years:

-25%, -25%, +33%, +33%, +25%

Over 4 years the investment will have recovered to break even and over 5 years the original investment will be up 25%, which is far better than paying 2.5% interest. Hold on a sec though, that loan needs to be paid monthly. To keep it simple, I'll make it annual:

End of year 1: Investment now $4,000, pay out $1,025 to cover loan, have $2,975 left
End of year 2: Investment now $2,230, pay out $1,025 to cover loan, have $1,200 left
End of year 3: Investment now $1,600, pay out $1,025 to cover loan, have $580 left
Year 4: You're screwed, you can't pay off the loan, and you still have about a year and a half left.

If you have other assets to sell, other spare disposable income, etc. you can cover that and in the long term you'll be fine. However the fact that you need to sell investments or not invest that money in order to pay that debt goes against the original advice given here, but sure in the long run you'll likely end up better off. If you don't have other assets, you're screwed, you can't pay off that loan and you've lost a big chunk of your original savings.

Click to shrink...

I completely agree you shouldn't overleverage yourself. That goes for houses, cars, pretty much anything. Ideally you have a safety net of 6-12 months expenses for all leveraged assets in something like a high-yield saving's account, rolling CDs or rolling TIPS. That is pretty much investing 101 so you don't have to sell during a downturn.

Your hypothetical market returns are incredibly unlikely though. You need to go back to the great depression to see back to back years of 25% losses and ethen you saw multiple years of of 40% gains after it.

Even if you invested right before the 2008 crash you'd have -37%, 26%, 15%, 2%, 16% which should result in ~8% gain. When you do the exact same thing you're next five years would be 32%, 13%, 1% 11%, 21%.

 

[Sheepinator]

I completely agree you shouldn't overleverage yourself. That goes for houses, cars, pretty much anything. Ideally you have a safety net of 6-12 months expenses for all leveraged assets in something like a high-yield saving's account, rolling CDs or rolling TIPS. That is pretty much investing 101 so you don't have to sell during a downturn.

Your hypothetical market returns are incredibly unlikely though. You need to go back to the great depression to see back to back years of 25% losses and ethen you saw multiple years of of 40% gains after it.

Even if you invested right before the 2008 crash you'd have -37%, 26%, 15%, 2%, 16% which should result in ~8% gain. When you do the exact same thing you're next five years would be 32%, 13%, 1% 11%, 21%.

Click to shrink...

S&P500 had a high of 1,576 in October 2007 and a low of 666 just 15 months later, a 58% decline.

Not having to sell during a downtown is key. Just saying, that's why the advice from some here that you should always invest while keeping a low interest loan because over a longer term horizon the market returns more, is actually quite risky if you don't have other liquid investments (including cash etc.) If such a strategy goes wrong the tenth time you do it, no big deal, but if it goes wrong the first time, that's very different.

 

[Cilidra]

Thanks, I appreciate the in-depth response. I figured that path was the most sound, but it's a little soul-crushing to learn that index funds only become a "sensible" option once someone is already investing $6,000 into an IRA and $19,000 into their 401K each year. $25,000 annually is quiet the chuck of change! I suppose index fund-investing is hardly for everybody.

Click to shrink...

You can select index funds for your 401k.
Index funds just describe a type of fund.
401k is just a legal term to describe a funds that is acquired under a special tax shelter law.
So an index funds purchased under the 401k designation is both.