This is the story of how a math mistake saved me money.

When my wife and I purchased our first home, I asked myself: Given a little extra disposable income, do I overpay my mortgage or invest that same amount in the stock market? After listening to a few financial pundits on the radio, I decided to overpay my mortgage. I did not do the math, I just relied on “expert opinions” to guide me.


Three and a half years ago, my wife and I purchased our second home and I decided that this time I would do it right. I did the calculations by applying the interest rate that I was paying at the time (5.65% over 30 years) and figuring in federal and state income tax. I came up with a return of about eight percent if I overpay my mortgage. So I started to overpay my mortgage instead of investing into the stock market. Well as it turns out, I had made a simple mistake in my Excel calculations. The return was actually less than four percent. I did not even realize my mistake until we refinanced our home at the end of December, 2008.

Thankfully, luck was on my side. Had I invested that money in the stock market, I would at this point have had negative returns. In the long run, however, I would not have lost out. I would have invested the dollar cost average over a number of years, buying stocks when they are high and when they are low, and my average return would have most likely beaten four percent.

After we refinanced, just before the new year, we got a 4.25% interest rate over 30 years. Figuring in federal and state income tax, we would probably receive a 2.9% rate of return. Having figured this out, I began putting my extra mortgage payments into the stock market indexes such as S&P 500, MSCI EAFE, MSCI US Small Cap 1750, etc., properly diversifying among all asset classes. Assuming that I will obtain approximately eight percent return over the long run and pay taxes on dividends and gains, I plan to be well ahead of the curve!

It is true that many financial pundits rave about overpaying your mortgage so that you can become debt free. However, if I can produce my mortgage balance from my bank account, that, to me, is also debt free. Furthermore, it is important to take into consideration the facts of life: what if you are overpaying your mortgage and you lose your job or are hit with extensive medical expenses? All of your built up disposable income is now sitting in the equity of your home and you must rely on bank loans (which you may or may not easily obtain).

So in case you are still wondering where I stand on the subject, here it is: overpaying your mortgage is not the best idea, assuming the interest rates are low as they are right now. If you have extra money, you are better off buying stock, mutual funds, or index funds. If you have the option, put the money in a Roth IRA so that it will grow tax free. Just do not try to time the market and switch frantically between investments. Be disciplined in this!


Alex Medvedovski

My niece, who is in her early 20s, asked whether it is too early to start saving for retirement.

To answer her question I just ran some simple math. First of all some assumptions: she would need money in 42 years, annual average rate of return on retirement savings is 8%, and inflation is 3% per year.

Scenario 1. She does not save for retirement for the next 12 years and then she would save $10,000 per year increasing it at rate for inflation (3%). In 42 years she might save $513,000 (in today's dollars it is about $150,000).

Scenario 2. She saves $2,000 for next 2 years (she will be in grad school with minimal income), then $5,000 per year increasing it at rate for inflation until she is ready to retire in 42 years. She would save $1,891,000 (in today's dollars it is about $550,000).

As you can see in the second scenario she would accumulate about three times as much money comparing with the first one by just saving earlier. It would allow her withdrawing $25-33K a year in retirement (in today's dollars) relatively safely. This would be my advice to her for right now.

Is it realistic? I think so. In two years when she finishes her Masters Degree most likely she will find a job that might pay around $50,000. So her retirement contributions would be about 10% from her pay.

You can say that maybe it is not enough. And I am not disagreeing with you. In my opinion this plan will enable my niece to get a habit of saving. The near term results (for next several years) are quite achievable adding to retirement savings little by little. She would see the results and get first hand experience with investing and compounding interest when money grows exponentially within no more than 10 years. When time flies by the plan will change. Most likely her income will grow, her lifestyle will change, she might get married, have kids, have mortgage and so on but she would feel better that her retirement savings are taken care.

Alex Medvedovski