I have a mortgage with a balloon payment due in 5 years. The rate is 5% fixed and the interest is fully deductible. I am inheriting enough money this quarter to pay off the mortgage now, but I know there must be a better way. I'd like to invest a fixed amount today and get a fixed amount out in 5 years to pay off the mortgage. I'd like to earn around 5 to 7%, but not be taxed during the 5 years I will hold the investment. In addition, I want the gain on the investment to be taxed at long term capital gain rates when I cash out the investment in 5 years. In other words, I want the time value of money on my taxes and I want the rate spread on capital gains.I know zero's won't work, because of the OID rules (taxed each year at ordinary rates). One more fact: I live in Washington state so there is no individual state income tax.Any ideas?
>>I'd like to invest a fixed amount today and get a fixed amount out in 5 years to pay off the mortgage. I'd like to earn around 5 to 7%, but not be taxed during the 5 years I will hold the investment. In addition, I want the gain on the investment to be taxed at long term capital gain rates when I cash out the investment in 5 years.<<If I understand correctly, you want a 5-7% return, tax deferred at cap gain rates, and no market risk to your principal. Sounds like investment nirvana. Let us know when you find it, others might like to participate.
I think you are looking for a zero coupon municipal bond, if you can find one. I don't know if you can get that interest rate on a 5 yr bond, but it should be Fed tax free.
I'm not looking for no market risk. I could achieve "no market risk" by just paying off the mortgage now. A 5% to 7% return requires some risk (obviously). A straight equity investment (such as a no load index fund) would theoretically yield a 10% return over the long run, but the variabily of such an investment is too high for what I have in mind and a 5 year time frame is too short to reasonably target a 10% return overall. A common stock equity investment would however defer taxes until I cashed out the investment (assuming capital appreciation and no dividends) and it would generate a long term taxable gain.A 5% to 7% return on an "equity" investment would be a relatively "safe" return by market standards (half the long term average return on US stocks). I'm just looking for ideas here. Preferred stock? Asset backed securities? Hedged equity investments?
I advise pay off the mortgage. You will find a peace of mind that will outway a possible payoff. I don't think you will find 7% return guaranteed without tax. It's not there so payoff the loan. That guarantees a return and you have more options like not being stuck with your job.Jesse
If it were me, I'd pay off the mortgage, then try to save the 2% or so per year on the mortgage payment you are hoping to get with a 7% return by cutting out wasteful expenditures—good discipline that would pay off for a lifetime.If you really want to take moderate risks with the money, you might try Vanguard's Target Retirement Fund that comes closest to the date your balloon payment comes due. These funds are a mix of stock, bond, and international indices, and designed for those who will need the money at the fund's target date. The stock portion will give you long term capital gains rate. The biggest worry will be if stocks and bonds collapse at the same time over the next 5 years (a very real possibility, unfortunately), though the international component might help some (unless everywhere goes bust at the same time).
I think you can get the 7% return with a decent basket of stocks. The problem comes in finding solid stocks that don't pay dividends so that you don't have any taxes along the way. That gets a little more challenging. I think I could meet that bogie, but I'm not about to offer up a list. Look for solid, ain't going anywhere, slow and steady growth stocks and you'll do fine. As you get fancy, you're risk grows. Also, once you have your nut (7%x5/5) covered, bank it or at least set stops. Don't watch it fall past your magic number. Good luck.nmckay
Loren wrote - A 5% to 7% return on an "equity" investment would be a relatively "safe" return by market standards (half the long term average return on US stocks). I'm just looking for ideas here. Preferred stock? Asset backed securities? Hedged equity investments?These levels of return are averages over long periods of time. Yes equities may average 10% over 100 years. Take a look at all 5 year segments and find out how many you find unacceptable for your "plan" -- I am sure from July 1929 through 1934 does not please you, but then 1937 to 1942 was not so good either. If you are willing to live with a 5 or 10% risk you will loose you shirt and have to refinance that balloon in 5 years what you propose might be OK. Now that also assumes that we are not in a housing bubble and that you will not be underwater -- banks just don't like loaning money for more then a house in worth at the time of the loan. (I think this is unlikely - but look at the last 5 years in Tech Land - Seattle & San Jose)For my view, 5 years is short. Pay off the mortgage or at least refinance it so you can not get killed with a balloon in 5 years.Gordon who is generally opposed to debt, both personally and in companies in which I invest.
TwoCybers wrote – "These levels of return are averages over long periods of time. Yes equities may average 10% over 100 years. Take a look at all 5 year segments and find out how many you find unacceptable for your 'plan'"Didn't I say that? – “The variability of such an investment is too high for what I have in mind and a 5 year time frame is too short to reasonably target a 10% return overall.”I'm not a fan of debt either, but I am a fan of higher overall returns. And I especially like saving taxes when I can. If I can deduct my mortgage interest against ordinary income for 5 more years and then pay tax on my invested funds at capital gain rates, in 5 years, I will come out ahead - as long as I “protect” my invested capital and earn at least 5% on my money. “Protection” and/or “risk” is relative. Everything in life involves some risk. Even paying off the mortgage today involves some risk: opportunity risk. If I pay off the mortgage, I won't have the funds available for potential opportunities - or rainy days - that may come my way in the next 5 years. For example, if I need the money in 3 years for a medical emergency, paying off the mortgage today might end up costing me more than my shirt. I've already learned the hard way how little medical insurance actually pays.I'm looking for relatively safe investment ideas that will yield 5-7% deferred gains taxable at capital gain rates. Lokicious has a good idea with the Vanguard Target Retirement Funds, although as he points out the gains won't all be deferred or taxable at capital gain rates. I'll look into that, though. Also, nmckay's idea on protecting my down-side on equity investments with stops is a good idea. Not bullet proof, but it probably would reduce my overall downside risk if I invest in equities.There's got to be some other ideas out there. What are asset backed securities and how are they taxed? What about hedging ideas, like nmckay's stops?
You could look at MO -- currently pays 5.6% and it is sufficently beat down that it is not going down much more. Any appreciation would be gravy.Gordon
You could look at MO -- currently pays 5.6% and it is sufficently beat down that it is not going down much more. Any appreciation would be gravy.I love MO and am still long MO. However, it was $24 less then 2 years ago simply on litigation fears.I would not recommend MO for anyone who doesn't have a LONG horizon.Splotto
The high in early 2002 was about $57.25 -- about $10 different then the current price. At least that is what I got from MSN Investor.GordonAtlanta
"I'm not looking for no market risk. I could achieve "no market risk" by just paying off the mortgage now. A 5% to 7% return requires some risk (obviously)". Not having sufficient data re your'e circumstances I will not make a specific rec. However if you purchase a AAA common stock and go into a covered call writing strategy you should be able to achieve a return of close to 10%. If you do a few sugestions. 1.Buy a divd. paying stock which is nuber one or two in its busisness segment and has been profitable for at least the last 5 years.2. Writ leaps somewhat above the then current market-I normally go to either one or two notches up. 3.DO NOT attempt to trade around the position unless you are a VERY experienced in options as the spreads and commissions are substantial. 4. If in Dec stock is well above the strike price buy in the call and take the Tax Loss-while you will have a tax loss the increase in the value of your'e common stock will almost always exceed the loss in the call because you will have pocketed the premium due to the decrese in the time value of thge option as well as the fact that it is by definition now "in the Money". The real danger is what to do if the stock goes down by an amount equal to the premium you have recieved-ans.-sell the stock but you may have to buy it back if it bounces back upto the strike price. If this all sounds like it requires attention-well it does.there is no free lunch. I can tell you that covered option writers over the years have done very well-no home runs but steady growth of between 7% to 20+%(in 98 and 99),with most years coming in at low double digits.
GREYFOX: Thank you for your reply. This is interesting and I've wanted to do some covered call writing with my other investment funds. I followed most of what you said, but a few buzz words through me off a little. Can you give me a few more details on these items: What are "leaps"? (Writing calls with a strike price higher than the current price?)What do you mean by "one or two notches" above the current price? What is "trading around the position"?Also, I would immagine that your covered stocks get called away fairly frequently. Generally, is the majority of your capital gain short term or long term - for tax purposes?Loren
Loren; Leaps are Long Term Equity Options-Always mature in Jan. Curently Jan. 05 or 06. 2. If The stock is curnetly $31 there will generally be jan 05 and 06 calls with a strike price @ 32 !/2 as well as @ 35.In some cases there may not be 32 !/2. 3. Trading options is very expensive therefore I usually do not try to repurchase options if they go down after I have sold-unless they get to nominal price-i.e.$0.10 per share. BUT if stock goes down as I said I may sell the stock and that leaves me short the call without the stock("naked"). Since this is HIGH RISK I have to buy back the stock if it goes back up to(+/-) the strike price. 4. In Taxable accounts i never rarely permit my stocks to be called away unless I have net capital losses for the year. If 30 stock goes to 50 the option will be selling in Dec(one month prior to Jan expiration) for about 15 if you wrote Jan 05 option@35.Lets say you received $2.50 per share when you sold the optionwhen stock was 32. You have an unrerealized gain on the stock of $18.You do not sell so no taxable gain.The option is now selling at 15 so you buy the option you sold short and you have a taxable short term loss of $12.50.
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