2016 has been a tough year. I know we’re not the only ones who’ve been feeling that. (Evidence: this NSFW video from John Oliver.) There’s all the ickiness in the world, the worst election cycle any of us can ever remember, the uncertainty now of what a new administration will mean for retirees, the loss of Prince and Bowie and Sharon Jones, plus we’ve just had an especially demanding and draining work year.
But 2016 has also been a pretty spectacular year for us financially, which we’re still having a hard time reconciling. So just picture us over here confusedly saying, “2016, you’re dead to us,” but also, “Oh, and thanks, 2016.” Strange days, you guys.
But despite the weirdness of this year, we’ve finally reached the end of it, and what is often our favorite part: when we find out what our year-end bonuses are. (And a semantic reminder: they’re really deferred compensation, not true bonuses, but “bonus” is shorter and makes more sense to people. We broke it all down last year in this post, if you’re curious.)
And this year in particular, the bonus amounts mean more than they ever have, because they will tell us if we can shave any time off of our retirement calendar. We’ll break this all down later in the month after we’ve gotten the word on our bonuses (we find out this week and next, so we’ll share info on the 19th), but I probably don’t need to tell you that we’re crossing every finger and toe, hoping for enough that we can retire mid-year 2017 instead of waiting until year end. Stay tuned…
In past years, we’ve had a pretty straightforward action to take at year end: allocate part of the bonus to hit our mortgage paydown target, and then put the rest in our investment accounts (primarily Vanguard index funds), all according to our projections for the year. Most years we’ve come in right on target or maybe just slightly over.
But this year we got way ahead of schedule, and we’re already past our taxable savings projections even before the bonuses come in. We’re still a way from our mortgage paydown target, because we didn’t allocate much extra to the mortgage this year beyond our regular payments. So our first action will be to pay down the mortgage as much as we had always planned to. But then we need to decide what to do with the extra, which could potentially be a significant sum.
So today: our debate on how to allocate this year’s additional funds: between our mortgage, our investment accounts and even our cash cushion. Let’s discuss!
Our Best Advice: Bank Your Windfalls
We don’t give a lot of directives around here, because we believe that personal finance is truly personal, and that what works for us may not work for everyone. (Besides, we’re really all just guessing about what’s “best” based on whatever information we happen to have. There is no single set of right answers on any of this stuff. Anyone who believes in one right answer has grown blind to their own bias.)
But, despite our aversion to advice-giving, the single best thing we’ve ever done for our finances, beside buying less house than we can afford, is to get in the habit of banking our windfalls. Now every cent that comes in above our regular paychecks — any work bonus, tax refund, bank error in our favor (not really a thing, unless you’re playing Monopoly) — goes straight into one of our savings vehicles. If you can get into this same habit, you’ll never regret it.
The Allocation Debate
There is no debate about spending vs. saving our bonuses. It’s just a question of how we’ll save them. We’ll take some off the top to get our mortgage down to the year-end target we set for it, so that we can have it paid off before we retire next year. But, we could potentially pay it all the way off this year. (So tempting! How awesome would it feel to own our home free and clear, and ahead of schedule?!) Or we could put the extra into our investment accounts and take them way past our projected 2016 target, making the possibility of an early 2017 retirement feel real. (Also tempting!) Or we could put some or all of that extra into our cash cushion that we plan to retire with, so that we’re basically able to retire at any time, without worrying about what the markets are doing at that moment and whether it’s a good time to sell shares.
Pros and Cons of Each Allocation
There’s no right answer here, but there are pros and cons to each potential allocation of our extra funds. Here’s how we see them, but if you have other thoughts, please chime in in the comments!
Invest in the markets
Pros: Research shows that giving yourself as much exposure to the markets wins out over dollar cost averaging over the long run (Vanguard says “Dollar cost averaging just means taking your risk later.“), meaning that we’ll tend to do best when we invest as much money as possible, as soon as possible. If we want our money to grow over time (we do!), we should be investing it in our index funds. Plus, investing more means we can get to our stretch goal by retirement, giving us more wiggle room in phase one of our retirement years.
Cons: The markets feel overvalued right now, and a correction or crash is feeling more and more inevitable with each passing day. As dedicated as we are to not trying to time the markets, it’s hard not to want to time the markets at the moment.
Pay extra against the mortgage
Pros: We have always planned to pay off the mortgage before we retire, so paying extra against the mortgage would only be accelerating our pay-off date by a matter of months. Extra money paid against the mortgage is also a guaranteed return of 3.75% in our case, which is better than any other guaranteed return out there right now, and certainly a better return than we’d get on the same money if we invested it and then a recession hit. Plus, we’d sleep so well at night knowing we no longer owe a penny on the house.
Cons: We’d lose market exposure on that money, meaning it can’t grow for us. We’d lose a small mortgage interest tax deduction (though that’s tiny at this point anyway since we’ve been paying off the mortgage aggressively). I’d be more tempted to quit working every day knowing that the house is paid off and we could keep our expenses very low. (<– This last point is Mr. ONL’s greatest fear about paying off the house ahead of schedule. He doesn’t think he’ll be able to convince me to keep working if we close out the mortgage. And he might not be wrong.)
Build up our cash reserves
Pros: We want to go into retirement with at least two years of cash reserves plus a little extra for emergencies, and we’re currently at a little over a year. Allocating money to cash reserves now would put us in a position to be able to retire at essentially any time, without worrying about what cash we have built up, or worrying whether we’d need to sell shares in bad market conditions or incur capital gains taxes.
Cons: Money allocated to cash wouldn’t be able to grow like our invested assets do, and wouldn’t reduce our debt like mortgage paydown would. Though getting our cash cushion up to two to three years of expenses is a necessary step to take before we can pull the plug, it’s the choice that feels the least gratifying.
Plus: More to Charity
Regardless of what we do with the main allocation areas, we’ve already committed to ourselves that we’re going to give more to charity this year than we ever have before, both in total dollars and in percentage of our income. We’re focused on building up our giving muscles, something not enough high earners do (we were shocked by the data, actually, that the poor give so much more than the rich do on average, and wrote about it here). Charitable causes need our volunteer time, but they mostly need our money, so let’s all give as much this year end as we possibly can.
How We’re Leaning
Mr. ONL: If it was only up to Mr. ONL, he’d put all the extra into our investment accounts to give it as much time as possible to grow. He also wants to stick to our work-all-of-2017 timeline, regardless of where we end up with bonuses, and says we have all of 2017 to finish paying off the house, plus next year’s bonuses to build up our cash reserves.
Me: I want to pay off the house, and badly. But I also want us to quit as early as we can next year, so see the mortgage payoff as a more urgent goal. After the mortgage, I’d put the rest into cash so we’re ready ASAP to pull the plug. And then we’ll make up for any shortfall in our investment account with post-retirement fun work. That is, if it was only up to me.
Our task over the next few weeks is to find agreement on what to do with our extra funds for the year, something that will become much easier to discuss once we know how much we’re actually talking about. And then we’ll tackle the bigger discussion of what it all means for our timeline. Lots still to figure out — stay tuned!
What Would You Do?
What would you do if you were in our shoes? How would you allocate our year-end funds across investments, the mortgage, cash reserves and charitable donations? Help us decide!