“There is no dollar sign
on a peace of mind
this I have come to know”
Zac Brown Band
There are many experts, gurus, and even phrophets out there spewing opinions and advice on how to live your life. Some of the advice are valid but majority of them are noise.
Thanks to the internet, almost anything you would like learn is easily seacheable and available. So, when I was questioning the idea of emergency funds and paid-off mortgages, I dived deep into the internet to hear the arguments. These are the most heavily discussed topics in personal finance. Everyone seems to have an opinion on these topics. So let us take a close look at – (A) Paying off mortgage vs. Investing, and (B) having a large emergency fund.
When it comes to early mortgage payoff, I’m undecided. I do understand the benefits and the appeal of a paid-off-house. But on the other side, I do prefer to invest instead of pre-paying my mortgage. A lot of research supports investing vs. eliminating the mortgage. Unless the interest on the mortgage is above 5% APR, I do not see the reason to put extra money in an illiquid asset.
If we were to look at the math, assuming mortgage interest of 4% or lower, it is better to invest the extra money. However, that is not what people do. Most people spend that extra cash instead of investing. For this reason, I would advice some people to pay extra on the mortgage if they’re not disciplined investors.
The other issue is Emergency Funds. I do agree that holding a large amount of cash is wasteful. For one, there is inflation. If the cash is not earning at least 2% back on interest, you are losing money. The Federal Reserve target is an inflation rate of 2%. The cash you have need to earn 2% or more to maintain its buying power.
The second reason why you should not hold large amounts of cash is the opportunity cost. Since the Great Recession, the Federal Reserve has held interest rates between 0 and 2%. That means, your bank will only pay you 0.1 to 2.5% interest on your savings. But if you invest the money, you would get the average of 7% back from the stock market. There is risk, but 7% is a lot better than 2% even with risk.
So, I do understand these topics and I try to adhere to my plan. However, humans are emotional creatures and emotions can override any form of intelligence. I tend to be risk averse. As a results, I hold a large emergency fund than necessary. The reason: I like my peace of mind. I sleep better knowing I do not have to sell my stocks to finance emergencies. I would also hate to sell stock if I lost a job during a recession.
The second reason I hold large emergency fund is because I want to pay off my mortgage soon. But it is a balance; I max out my retirement, then invest in a brokerage account, then I save a certain amount of cash. I do not put the extra cash in the mortgage. I have saved most of it in CD accounts. The goal is, at one point, I will have enough to pay off the mortgage early. In the mean time, that money buys me a peace of mind since it remains liquid. I do not want to be the person who puts extra cash in the mortgage, then loses a job, and then foreclose on the house. The bank owns the house until you have paid 100% of the mortgage.
So, for those people who are trying to decide if holding emergency fund or paying the mortgage early is worth it, please do your own research and make sure you understand the basics.
For me, the reason for having money is to have options and freedom. I value my peace of mind provided buy the emergency fund. Soon, I will have added the ‘psychological benefit’ of a paid-off house. Even though I’m incurring opportunity cost, I’m ok paying that cost to not worry or stress about money.
Thank you for reading.
